The first rule is sell any stock that falls 8% below your purchase price. Why 8%?
The first rule is - sell any stock that falls 8% below your purchase price. Why 8%? Because research confirms that stocks with all the right fundamental and technical factors and bought at the proper buy point rarely will fall by 8%. If they do, there's something wrong with them.
| Sell the stock if it falls 8% below your purchase price.
|| For example
| Your purchase price per share
|| Rs. 100
| The stock price falls to
|| Rs. 92 or lower [8% fall from your purchase price of Rs. 100]
| Your decision should be
| Make no exceptions to the rule.
You may think a stock is due to rebound. But the market could send the stock to
lower depths regardless of your views or what analysts and commentators say on TV.
No excuses, no alibis. You may want to sell even before an 8% loss if you see other
signs of weakness in a stock.
This rule emphasizes the importance of buying at the right time. If you don't and
you buy a stock that is overextended (that's reaching the end of its climb), chances
are it will hit the 8% sell level as it goes through a normal pullback. Make no
exceptions to the rule. The best stocks will always give you other opportunities
to buy. Here's another way to look at it: Once a stock falls 8% below your cost,
does it still look attractive? Is it still among the best stocks? Probably not.
There's no guarantee that it will go back up, and you need to protect yourself.
The bigger the fall, the harder it is to recover. Say you bought a stock at Rs.100
a share. It falls 20%, to $80. To get back to Rs.100, the stock has to make a 25%
gain. Another example: The stock plummets 50%, to Rs.50 a share. It would take a
100% jump to get it back to Rs.100 - and how often do you buy a stock that doubles?
And if it does, how many weeks, months or even years does it take to get there?
Wouldn't you rather cut your loss early, and free up money to purchase another stock
with better chances of doubling?
Of course, it could happen that you sell a stock that falls 8%, and then watch it
go up afterward. But you have to think of the 8% sell rule as your insurance policy
against catastrophic losses. The rule will in effect limit any losses on your portfolio
to no worse than 8%.
Nevertheless, if you've bought a fundamentally sound stock at the right point, (explained
in the stock buying lessons) it will rarely plunge 8% immediately. Buying exactly
right will solve half your selling questions.