CHAPTER 11
When to Sell and Take Your Worthwhile Profits

This is one of the most vital chapters in this book, covering an essential subject few investors handle right. So study it carefully. Common stock is just like any merchandise. You, as the merchant, must sell your stock if you’re to realize a profit, and the best way to sell a stock is while it’s on the way up, still advancing and looking strong to everyone.

This is completely contrary to human nature. It means selling when your stock is strong, up a lot in price, and looks like it will make even more profit for you. But when you sell like this, you won’t be caught in heartrending 20% to 40% corrections that can hit market leaders and put downside pressure on your portfolio. You’ll never sell at the top, so don’t kick yourself when some stocks go higher after you sell.

If you don’t sell early, you’ll be late. Your object is to make and take significant gains and not get excited, optimistic, greedy, or emotionally carried away as your stock’s advance gets stronger. Keep in mind the old saying: “Bulls make money and bears make money, but pigs get slaughtered.”

The basic objective of your account should be to show a net profit. To retain worthwhile profits, you must sell and take them. The key is knowing when to do just that.

Bernard Baruch, the financier who built a fortune in the stock market, said, “Repeatedly, I have sold a stock while it was still rising—and that has been one reason why I have held on to my fortune. Many a time, I might have made a good deal more by holding a stock, but I would also have been caught in the fall when the price of the stock collapsed.”

When asked if there was a technique for making money on the stock exchange, Nathan Rothschild, the highly successful international banker, said, “There certainly is. I never buy at the bottom, and I always sell too soon.”

Joe Kennedy, one-time Wall Street speculator and father of popular former President John F. Kennedy, believed “only a fool holds out for the top dollar.” “The object,” he said, “is to get out while a stock is up before it has a chance to break and turn down.” And Gerald M. Loeb, a highly successful financier, stressed “once the price has risen into estimated normal or overvaluation areas, the amount held should be reduced steadily as quotations advance.”

What all these Wall Street legends believed was this: you simply must get out while the getting is good. The secret is to hop off the elevator on one of the floors on the way up and not ride it back down again.

You Must Develop a Profit-and-Loss Plan

To be a big success in the stock market, you must have definite rules and a profit-and-loss plan. I developed many of the buy and sell rules described in this book in the early 1960s, when I was a young stockbroker with Hayden, Stone. These rules helped me buy a seat on the New York Stock Exchange and start my own firm shortly thereafter. When I started out, though, I concentrated on developing a set of buy rules that would locate the very best stocks. But as you’ll see, I had only half of the puzzle figured out.

My buy rules were first developed in January 1960, when I analyzed the three best-performing mutual funds of the prior two years. The standout was the then-small Dreyfus Fund, which racked up gains twice as large as those of many of its competitors.

I sent for copies of every Dreyfus quarterly report and prospectus from 1957 to 1959. The prospectus showed the average cost of each new stock the fund purchased. Next, I got a book of stock charts and marked in red the average price Dreyfus paid for its new holdings each quarter.

After looking at more than a hundred new Dreyfus purchases, I made a stunning discovery: every stock had been bought at the highest price it had sold for in the past year. In other words, if a stock had bounced between $40 and $50 for many months, Dreyfus bought it as soon as it made a new high in price and traded between $50 and $51. The stocks had also formed certain chart price patterns before leaping into new high ground. This gave me two vitally important clues: buying on new highs from basing patterns was important, and certain chart patterns spelled big profit potential.

Jack Dreyfus Was a Chartist

Jack Dreyfus was a chartist and a tape reader. He bought all his stocks based on market action, and only when the price broke to new highs off sound chart patterns. He was also beating the pants off every competitor who ignored the real-world facts of market behavior (supply and demand) and depended only on fundamental, analytical personal opinions.

Jack’s research department in those early, big-performance days consisted of three young Turks who posted the day’s price and volume action of hundreds of listed stocks to very oversized charts. I saw these charts one day when I visited Dreyfus’s headquarters in New York.

Shortly thereafter, two small funds run by Fidelity in Boston started doing the same thing. They, too, produced superior results. One was managed by Ned Johnson, Jr., and the other by Jerry Tsai. Almost all the stocks that the Dreyfus and Fidelity funds bought also had strong increases in their quarterly earnings reports.

So the first buy rules I made in 1960 were as follows:

1. Concentrate on listed stocks that sell for more than $20 a share with at least some institutional acceptance.

2. Insist that the company show increases in earnings per share in each of the past five years and that the current quarterly earnings are up at least 20%.

3. Buy when the stock is making or about to make a new high in price after emerging from a sound correction and price consolidation period. This breakout should be accompanied by a volume increase to at least 50% above the stock’s average daily volume.

The first stock I bought under my new set of buy rules was Universal Match in February 1960. It doubled in 16 weeks, but I failed to make much money because I didn’t have much money to invest. I was just getting started as a stockbroker, and I didn’t have many customers. I also got nervous and sold it too quickly. Later that year, sticking with my well-defined game plan, I selected Procter & Gamble, Reynolds Tobacco, and MGM. They, too, made outstanding price moves, but I still didn’t make much money because the money I had to invest was limited.

About this time, I was accepted to Harvard Business School’s first Program for Management Development (PMD). In what little extra time I had at Harvard, I read a number of business and investment books in the library. The best was How to Trade in Stocks, by Jesse Livermore. From this book, I learned that your objective in the market was not to be right, but to make big money when you were right.

Jesse Livermore and Pyramiding

After reading his book, I adopted Livermore’s method of pyramiding, or averaging up, when a stock advanced after I purchased it. “Averaging up” is a technique where, after your initial stock purchase, you buy additional shares of the stock when it moves up in price. This is usually warranted when the first purchase of a stock is made precisely at a correct pivot, or buy, point and the price has increased 2% or 3% from the original purchase price. Essentially, I followed up what was working with additional but always smaller purchases, allowing me to concentrate my buying when I seemed to be right. If I was wrong and the stock dropped a certain amount below my cost, I sold the stock to cut short every loss.

This is very different from how the majority of people invest. Most of them average down, meaning they buy additional shares as a stock declines in price in order to lower their cost per share. But why add more of your hard-earned money to stocks that aren’t working? That’s a bad plan.

Learning by Analysis of My Failures

In the first half of 1961, my rules and plan worked great. Some of the top winners I bought that year were Great Western Financial, Brunswick, KerrMcGee, Crown Cork & Seal, AMF, and Certain-teed. But by summer, all was not well.

I had bought the right stocks at exactly the right time and I had pyramided with several additional buys, so I had good positions and profits. But when the stocks finally topped, I held on too long and watched my profits vanish. If you’ve been investing for a while, I’ll bet you know exactly what I’m talking about. It’s a problem you must tackle and solve if you want real results. When you snooze, you lose. It was hard to swallow. I’d been dead right on my stock selections for more than a year, but I had just broken even.

I was so upset that I spent the last six months of 1961 carefully analyzing every transaction I had made during the prior year. Much like doctors do postmortem operations and the Civil Aeronautics Board conducts postcrash investigations, I took a red pen and marked on charts exactly where each buy and sell decision was made. Then I overlaid the general market averages.

Eventually my problem became crystal clear: I knew how to select the best leading stocks at the right time, but I had no plan for when to sell them and take profits. I had been completely clueless, a real dummy. I was so unaware that I had never even thought about when a stock should be sold and a profit taken. My stocks went up and then down like yo-yos, and my paper profits were wiped out.

For example, the way I handled Certain-teed, a building materials company that made shell homes, was especially poor. I bought the stock in the low $20s, but during a weak moment in the market, I got scared and sold it for only a two- or three-point gain. Certain-teed went on to triple in price. I was in at the right time, but I didn’t recognize what I had and failed to capitalize on a phenomenal opportunity.

My analysis of Certain-teed and other such personal failures proved to be the critical key to my seeing what I had been doing wrong that I had to correct if I was to get on the right track to future success. Have you ever analyzed every one of your failures so you can learn from them? Few people do. What a tragic mistake you’ll make if you don’t look carefully at yourself and the decisions you’ve made in the stock market that did not work. You get better only when you learn what you’ve done wrong.

This is the difference between winners and losers, whether in the market or in life. If you got hurt in the 2000 or 2008 bear market, don’t get discouraged and quit. Plot out your mistakes on charts, study them, and write some additional new rules that, if you follow them, will correct your mistakes and let you avoid the actions that cost you a lot of time and money. You’ll be that much closer to fully capitalizing on the next bull market. And in America, there will be many future bull markets. You’re never a loser until you quit and give up or start blaming other people, like most politicians do. If you do what I’ve suggested here, it could just change your whole life.

“There are no secrets to success,” said General Colin Powell, former secretary of state. “It is the result of preparation, hard work, and learning from failure.”

My Revised Profit-and-Loss Plan

As a result of my analysis, I discovered that successful stocks, after breaking out of a proper base, tend to move up 20% to 25%. Then they usually decline, build new bases, and in some cases resume their advances. With this new knowledge in mind, I made a rule that I’d buy each stock exactly at the pivot buy point and have the discipline not to pyramid or add to my position at more than 5% past that point. Then I’d sell each stock when it was up 20%, while it was still advancing.

In the case of Certain-teed, however, the stock ran up 20% in just two weeks. This was the type of super winner I was hoping to find and capitalize on the next time around. So, I made an absolutely important exception to the “sell at +20% rule”: if the stock was so powerful that it vaulted 20% in only one, two, or three weeks, it must be held for at least eight weeks from its buy point. Then it would be analyzed to see if it should be held for a possible six-month long-term capital gain. (Six months was the long-term capital gains period at that time.) If a stock fell below its purchase price by 8%, I would sell it and take the loss.

So, here was the revised profit-and-loss plan: take 20% profits when you have them (except with the most powerful of all stocks) and cut your losses at a maximum of 8% below your purchase price.

The plan had several big advantages. You could be wrong twice and right once and still not get into financial trouble. When you were right and you wanted to follow up with another, somewhat smaller buy in the same stock a few points higher, you were frequently forced into a decision to sell one of your more laggard or weakest performers. The money in your slower-performing stock positions was continually force-fed into your best performers.

Over a period of years, I came to almost always make my first follow-up purchase automatically as soon as my initial buy was up 2% or 2½% in price. This lessened the chance I might hesitate and wind up making the additional buy when the stock was up 5% to 10% or not add at all.

When you appear to be right, you should always follow up. When a boxer in the ring finally has an opening and lands a powerful punch, he must always follow up his advantage . . . if he wants to win.

By selling your laggards and putting the proceeds into your winners, you are putting your money to far more efficient use. You could make two or three 20% plays in a good year, and you wouldn’t have to sit through so many long, unproductive corrections while a stock built a whole new base.

A 20% gain in three to six months is substantially more productive than a 20% gain that takes 12 months to achieve. Two 20% gains compounded in one year equals a 44% annual rate of return. When you’re more experienced, you can use full margin (buying power in a margin account), and increase your potential compounded return to nearly 100%.

How I Discovered the General Market System

Another exceedingly profitable observation made from analyzing every one of my money-losing, out-of-ignorance mistakes was that most of my market-leading stocks that topped had done so because the general market started into a decline of 10% or more. This conclusion finally led to my discovering and developing our system of interpreting the daily general market averages’ price and volume chart. It gave us the critical ability to establish the true trend and major changes of direction in the overall market.

Three months later, by April 1, 1962, following all of my selling rules had automatically forced me out of every stock. I was 100% in cash, with no idea the market was headed for a real crash that spring. This is the fascinating thing: the rules will force you out, but you don’t know how bad it can really get. You just know it’s going down and you’re out, which sooner or later will be worth its weight in gold to you. That’s what happened in 2008. Our rules forced us out, and we had no idea the market was headed for a major breakdown. Most institutional investors were affected because their investment policy was to be fully invested (95% to 100%).

In early 1962, I had finished reading Reminiscences of a Stock Operator, by Edwin LeFevre. I was struck by the parallels between the stock market panic of 1907, which LeFevre discussed in detail, and what seemed to be happening in April 1962. Since I was 100% in cash and my daily Dow analysis said the market was weak at that point, I began to sell short stocks such as Certain-teed and Alside (an earlier sympathy play to Certain-teed). For this, I got into trouble with Hayden, Stone’s home office on Wall Street. The firm had just recommended Certain-teed as a buy, and here I was going around telling everyone it was a short sale. Later in the year, I sold Korvette short at over $40. The profits from both of these short sales were good.

By October 1962, during the Cuban missile crisis, I was again in cash. A day or two after the Soviet Union backed down from President Kennedy’s wise naval blockade, a rally attempt in the Dow Jones Industrial Average followed through, signaling a major upturn according to my new system. I then bought the first stock of the new bull market, Chrysler, at 58. It had a classic cup-with-handle base.

Throughout 1963, I simply followed my rules to the letter. They worked so well that the “worst”-performing account I managed that year was up 115%. It was a cash account. Other accounts that used margin were up several hundred percent. There were many individual stock losses, but they were usually small, averaging 5% to 6%. Profits, on the other hand, were awesome because of the concentrated positions we built by careful, disciplined pyramiding when we were right.

Starting with only $4,000 or $5,000 that I had saved from my salary, plus some borrowed money and the use of full margin, I had three back-to-back big winners: Korvette on the short side in late 1962, Chrysler on the buy side, and Syntex, which was bought at $100 per share with the Chrysler profit in June 1963. After eight weeks, Syntex was up 40%, and I decided to play this powerful stock out for six months. By the fall of 1963, the profit had topped $200,000, and I decided to buy a seat on the New York Stock Exchange. So don’t ever let anyone tell you it can’t be done! You can learn to invest wisely if you’re willing to study all of your mistakes, learn from them, and write new self-correcting rules. This can be the greatest opportunity of a lifetime, if you are determined, not easily discouraged, and willing to work hard and prepare yourself. Anyone can make it happen.

For me, many long evenings of study led to precise rules, disciplines, and a plan that finally worked. Luck had nothing to do with it; it was persistence and hard work. You can’t expect to watch television, drink beer, or party with your friends every night and still find the answers to something as complicated as the stock market or the U.S. economy.

In America, anyone can do anything by working at it. There are no limits placed on you. It all depends on your desire and your attitude. It makes no difference where you’re from, what you look like, or where you went to school. You can improve your life and your future and capture the American Dream. And you don’t have to have a lot of money to start.

If you get discouraged at times, don’t ever give up. Go back and put in some detailed extra effort. It’s always the study and learning time that you put in after nine to five, Monday through Friday, that ultimately makes the difference between winning and reaching your goals, and missing out on truly great opportunities that really can change your whole life.

Two Things to Remember about Selling

Before we examine the key selling rules one by one, keep these two key points in mind.

First, buying precisely right solves most of your selling problems. If you buy at exactly the right time off a proper daily or weekly chart base in the first place, and you do not chase or pyramid a stock when it’s extended in price more than 5% past a correct pivot buy point, you will be in a position to sit through most normal corrections. Winning stocks very rarely drop 8% below a correct pivot buy point. In fact, most big winners don’t close below their pivot point. Buying as close to the pivot point as possible is therefore absolutely essential and may let you cut the smaller number of resulting losses more quickly than 8%. A stock might have to drop only 4% or 5% before you know something could be wrong.

Second, beware of the big-block selling you might see on a ticker tape or your PC just after you buy a stock during a bull market. The selling might be emotional, uninformed, temporary, or not as large (relative to past volume) as it appears. The best stocks can have sharp sell-offs for a few days or a week. Consult a weekly basis stock chart for an overall perspective to avoid getting scared or shaken out in what may just be a normal pullback. In fact, 40% to 60% of the time, a winning stock may pull back to its exact buy point or slightly below and try to shake you out. But it should not be down 8% unless you chased it too high in price when you bought it. If you’re making too many mistakes and nothing seems to be working for you, check and make sure you’re not making a number of your buys 10%, 15%, or 20% above the precise, correct buy point. Chasing stocks rarely works. You can’t buy when you get more excited. So stop chasing extended stocks.

Technical Sell Signs

By studying how the greatest stock market winners, as well as the market itself, all topped, I came up with the following list of factors that occur when a stock tops and rolls over. Perhaps you’ve noticed that few of the selling rules involve changes in the fundamentals of a stock. Many big investors get out of a stock before trouble appears on the income statement. If the smart money is selling, so should you. Individual investors don’t stand much chance when institutions begin liquidating large positions. You buy with heavy emphasis on the fundamentals, such as earnings, sales, profit margins, return on equity, and new products, but many stocks peak when earnings are up 100% and analysts are projecting continued growth and higher price targets.

On the same day in 1999 that I sold Charles Schwab stock on a climax top run-up and an exhaustion gap, one of the largest brokerage firms in America projected that the stock would go up 50 points more. Virtually all of my successful stocks were sold on the way up, while they were advancing and the market was not affected. A bird in the hand is worth two imaginary ones in the bush. Therefore, you must frequently sell based on unusual market action (price and volume movement), not personal opinions from Wall Street. You must wean yourself from listening to personal opinions. Since I never worked on Wall Street, I never got distracted by these diversions.

There are many signals to look for when you’re trying to recognize when a stock could be in a topping process. These include the price movement surrounding climax tops, adverse volume, and other weak action. A lot of this will become clearer to you as you continue to study this information and apply it to your daily decision making. These rules and principles have been responsible for most of my better decisions in the market, but they can seem a bit complicated at first. I suggest that you reread Chapter 2 on chart reading, then read these selling rules again.

In fact, most of the IBD subscribers I’ve met at our hundreds of workshops who have enjoyed real success with their investments have told me that they read this entire book two or three times, or even more. You probably aren’t going to get it all in one reading. Some who have been distracted by all the outside noise say that they read it periodically to help them get back on the right track.

Climax Tops

Many leading stocks top in an explosive fashion. They make climax runs—suddenly advancing at a much faster rate for one or two weeks after an advance of many months. In addition, they often end in exhaustion gaps—when a stock’s price opens up on a gap from the prior day’s close, on heavy volume. These and related bull market climax signals are discussed in detail here.

1. Largest daily price run-up. If a stock’s price is extended—that is, if it’s had a significant run-up for many months from its buy point off a sound and proper base—and it closes for the day with a larger price increase than on any previous up day since the beginning of the whole move up, watch out! This usually occurs very close to a stock’s peak.

2. Heaviest daily volume. The ultimate top might occur on the heaviest volume day since the beginning of the advance.

3. Exhaustion gap. If a stock that’s been advancing rapidly is greatly extended from its original base many months ago (usually at least 18 weeks out of a first- or second-stage base and 12 weeks or more if it’s out of a later-stage base) and then opens on a gap up in price from the previous day’s close, the advance is near its peak. For example, a two-point gap in a stock’s price after a long run-up would occur if it closed at its high of $50 for the day, then opened the next morning at $52 and held above $52 during the day. This is called an exhaustion gap.

4. Climax top activity. Sell if a stock’s advance gets so active that it has a rapid price run-up for two or three weeks on a weekly chart, or for seven of eight days in a row or eight of ten days on a daily chart. This is called a climax top. The price spread from the stock’s low to its high for the week will almost always be greater than that for any prior week since the beginning of the original move many months ago.

In a few cases, around the top of a climax run, a stock may retrace the prior week’s large price spread from the prior week’s low to its high point and close the week up a little, with volume remaining very high. I call this “railroad tracks” because on a weekly chart, you’ll see two parallel vertical lines. This is a sign of continued heavy volume distribution without real additional price progress for the week.

5. Signs of distribution. After a long advance, heavy daily volume without further upside price progress signals distribution. Sell your stock before unsuspecting buyers are overwhelmed. Also know when savvy investors are due to have a long-term capital gain.

6. Stock splits. Sell if a stock runs up 25% to 50% for one or two weeks on a stock split. In a few rare cases, such as Qualcomm at the end of 1999, it could be 100%. Stocks tend to top around excessive stock splits. If a stock’s price is extended from its base and a stock split is announced, in many cases the stock could be sold.

7. Increase in consecutive down days. For most stocks, the number of consecutive down days in price relative to up days in price will probably increase when the stock starts down from its top. You may see four or five days down, followed by two or three days up, whereas before you would have seen four days up and then two or three down.

8. Upper channel line. You should sell if a stock goes through its upper channel line after a huge run-up. (On a stock chart, channel lines are somewhat parallel lines drawn by connecting the lows of the price pattern with one straight line and then connecting three high points made over the past four to five months with another straight line.) Studies show that stocks that surge above their properly drawn upper channel lines should be sold.

9. 200-day moving average line. Some stocks may be sold when they are 70% to 100% or more above their 200-day moving average price line, although I have rarely used this one.

10. Selling on the way down from the top. If you didn’t sell early while the stock was still advancing, sell on the way down from the peak. After the first breakdown, some stocks may pull back up in price once.

Low Volume and Other Weak Action

1. New highs on low volume. Some stocks will make new highs on lower or poor volume. As the stock goes higher, volume trends lower, suggesting that big investors have lost their appetite for the stock.

2. Closing at or near the day’s price low. Tops can also be seen on a stock’s daily chart in the form of “arrows” pointing down. That is, for several days, the stock will close at or near the low of the daily price range, fully retracing the day’s advance.

3. Third- or fourth-stage bases. Sell when your stock makes a new high in price off a third- or fourth-stage base. The third time is seldom a charm in the market. By then, an advancing stock has become too obvious, and almost everyone sees it. These late-stage base patterns are often faulty, appearing wider and looser. As much as 80% of fourth-stage bases should fail, but you have to be right in determining that this is a fourth-stage base.

4. Signs of a poor rally. When you see initial heavy selling near the top, the next recovery will follow through weaker in volume, show poor price recovery, or last fewer days. Sell on the second or third day of a poor rally; it may be the last good chance to sell before trend lines and support areas are broken.

5. Decline from the peak. After a stock declines 8% or so from its peak, in some cases examination of the previous run-up, the top, and the decline may help you determine whether the advance is over or whether a normal 8% to 15% correction is in progress. You may occasionally want to sell if a decline from the peak exceeds 12% or 15%.

6. Poor relative strength. Poor relative price strength can be another reason for selling. Consider selling when a stock’s IBD’s Relative Price Strength Rating drops below 70.

7. Lone Ranger. Consider selling if there is no confirming price strength by any other important member of the same industry group.

Breaking Support

Breaking support occurs when stocks close for the week below established major trend lines.

1. Long-term uptrend line is broken. Sell if a stock closes at the end of the week below a major long-term uptrend line or breaks a key price support area on overwhelming volume. An uptrend line should connect at least three intraday or intraweek price lows occurring over a number of months. Trend lines drawn over too short a time period aren’t valid.

2. Greatest one-day price drop. If a stock has already made an extended advance and suddenly makes its greatest one-day price drop since the beginning of the move, consider selling if the move is confirmed by other signals.

3. Falling price on heavy weekly volume. In some cases, sell if a stock breaks down on the largest weekly volume in its prior several years.

4. 200-day moving average line turns down. After a prolonged upswing, if a stock’s 200-day moving average price line turns down, consider selling the stock. Also, sell on new highs if a stock has a weak base with much of the price work in the lower half of the base or below the 200-day moving average price line.

5. Living below the 10-week moving average. Consider selling if a stock has a long advance, then closes below its 10-week moving average and lives below that average for eight or nine consecutive weeks, unable to rally and close the week above the line.

Other Prime Selling Pointers

1. If you cut all your losses at 7% or 8%, take a few profits when you’re up 20%, 25%, or 30%. Compounding three gains like this could give you an overall gain of 100% or more. However, don’t sell and take a 25% or 30% gain in any market leader with institutional support that’s run up 20% in only one, two, or three weeks from the pivot buy point on a proper base. Those could be your big leaders and should be held for a potentially greater profit.

2. If you’re in a bear market, get off margin, raise more cash, and don’t buy very many stocks. If you do buy, maybe you should take 15% profits and cut all your losses at 3%.

3. In order to sell, big investors must have buyers to absorb their stock. Therefore, consider selling if a stock runs up and then good news or major publicity (a cover article in BusinessWeek, for example) is released.

4. Sell when there’s a great deal of excitement about a stock and it’s obvious to everyone that the stock is going higher. By then it’s too late. Jack Dreyfus said, “Sell when there is an overabundance of optimism. When everyone is bubbling over with optimism and running around trying to get everyone else to buy, they are fully invested. At this point, all they can do is talk. They can’t push the market up anymore. It takes buying power to do that.” Buy when you’re scared to death and others are unsure. Wait until you’re happy and tickled to death to sell.

5. In most cases, sell when the percentage increases in quarterly earnings slow materially (or by two-thirds from the prior rate of increase) for two consecutive quarters.

6. Be careful of selling on bad news or rumors; they may be of temporary influence. Rumors are sometimes started to scare individual investors—the little fish—out of their holdings.

7. Always learn from all your past selling mistakes. Do your own postanalysis by plotting your past buy and sell points on charts. Study your mistakes carefully, and write down additional rules to avoid past mistakes that caused excessive losses or big missed opportunities. That’s how you become a savvy investor.

When to Be Patient and Hold a Stock

Closely related to the decision on when to sell is when to sit tight. Here are some suggestions for doing just that.

Buy growth stocks where you can project a potential price target based on earnings estimates for the next year or two and possible P/E expansion from the stock’s original base breakout. Your objective is to buy the best stock with the best earnings at exactly the right time and to have the patience to hold it until you have been proven right or wrong.

In a few cases, you may have to allow 13 weeks after your first purchase before you conclude that a stock that hasn’t moved is a dull, faulty selection. This, of course, applies only if the stock did not reach your defensive, loss-cutting sell price first. In a fast-paced market, like the one in 1999, tech stocks that didn’t move after several weeks while the general market was rallying could have been sold earlier, and the money moved into other stocks that were breaking out of sound bases with top fundamentals.

When your hard-earned money is on the line, it’s more important than ever to pay attention to the general market and check IBD’s “The Big Picture” column, which analyzes the market averages. In both the 2000 top and the top in the 2007–2008 market, “The Big Picture” column and our sell rules got many subscribers out of the market and helped them dodge devastating declines.

If you make new purchases when the market averages are under distribution, topping, and starting to reverse direction, you’ll have trouble holding the stocks you’ve bought. (Most breakouts will fail, and most stocks will go down, so stay in phase with the general market. Don’t argue with a declining market.)

After a new purchase, draw a defensive sell line in red on a daily or weekly graph at the precise price level at which you will sell and cut your loss (8% or less below your buy point). In the first one to two years of a new bull market, you may want to give stocks this much room on the downside and hold them until the price touches the sell line before selling.

In some instances, the sell line may be raised but kept below the low of the first normal correction after your initial purchase. If you raise your loss-cutting sell point, don’t move it up too close to the current price. This will keep you from being shaken out during any normal weakness.

You definitely shouldn’t continue to follow a stock up by raising stop-loss orders because you will be forced out near the low of an inevitable, natural correction. Once your stock is 15% or more above your purchase price, you can begin to concentrate on the price where or under what rules you will sell it on the way up to nail down your profit.

Any stock that rises close to 20% should never be allowed to drop back into the loss column. If you buy a stock at $50 and it shoots up to $60 (+20%) or more, even if you don’t take the profit when you have it, there’s no intelligent reason to ever let the stock drop all the way back to $50 or below and create a loss. You may feel embarrassed, ridiculous, and not too bright if you buy at $50, watch the stock hit $60, and then sell at $50 to $51. But you’ve already made the mistake of not taking your profit. Now avoid making a second mistake by letting it develop into a loss. Remember, one important objective is to keep all your losses as small as possible.

Also, major advances require time to complete. Don’t take profits during the first eight weeks of a move unless the stock gets into serious trouble or is having a two- or three-week “climax” run-up on a stock split in a late-stage base. Stocks that show a 20% profit in less than eight weeks should be held through the eight weeks unless they are of poor quality without institutional sponsorship or strong group action. In many cases, stocks that advance dramatically by 20% or more in only one to four weeks are the most powerful stocks of all—capable of doubling, tripling, or more. If you own one of these true CAN SLIM market leaders, try to hold it through the first couple of times it pulls back in price to, or slightly below, its 10-week moving average price line. Once you have a decent profit, you could also try to hold the stock through its first short-term correction of 10% to 20%.

When a stock breaks out of a proper base, after its first move up, 80% of the time it will pull back somewhere between its second and its sixth week out of the base. Holding for eight weeks, of course, gets you through this first selling squall and into a resumed uptrend, and you’ll then have a better profit cushion.

Remember, your objective is not just to be right but to make big money when you are right. “It never is your thinking that makes big money,” said Livermore. “It’s the sitting.” Investors who can be right and sit tight are rare. It takes time for a stock to make a large gain.

The first two years of a new bull market typically provide your best and safest period, but they require courage, patience, and profitable sitting. If you really know and understand a company thoroughly and its products well, you’ll have the crucial additional confidence required to sit tight through several inevitable but normal corrections. Achieving giant profits in a stock takes time and patience and following rules.

You’ve just read one of the most valuable chapters in this book. If you review it several times and adopt a disciplined profit-and-loss plan for your own investments, it could be worth several thousand times what you paid for this book. You might even make a point of rereading this chapter once every year.

You can’t become a big winner in the stock market until you learn to be a good seller as well as a good buyer. Readers who followed these historically proven sell rules during 2000 nailed down most of the substantial gains they made in 1998 and 1999. A few serious students made 500% or more during that fast-moving period. Again in 2008, an even greater percentage of Investor’s Business Daily readers, although not every one, after much work and study were able to implement proper selling rules to protect and preserve their hard-earned capital rather than succumb to the dramatic declines in the year’s third and fourth quarters.