Hopes are soaring when you buy that great-looking stock. But the truth is that precious few turn out to be monster achievers.
Unless the stock tells you otherwise, you're best off taking at least some of your chips off the table when the stock rises 20% or 25%.
Taking some — or all — of your profit in that zone is a key sell rule. This is called an offensive sale: You're selling into strength, not into weakness.
The 20%-to-25% zone is not a random target. The action of many winners show their rallies can peter out at about that spot.
It doesn't mean the stock is dead (although it could be). But some sort of serious backing and filling may be due.
You can be further motivated by unloading at that gain if you see other problems start to creep in.
Maybe the recent gains carried low . Maybe daily trading ranges are getting too wide. Maybe the stock's industry peers are outperforming.
Might the stock keep going up? Certainly. But at or near 25%, your risk-reward ratio has shifted radically, and not in your favor. Now you have all this downside to worry about. If you aren't confident about the stock's upside, then the ratio no longer works for you.
Consider, too, what happens when you sell that stock. You're raising cash.
If the market is in an uptrend, there should be other top-rated stocks within buying range. The stock you're selling should be well beyond buying range. You're probably trading your tired old horse for a fresh steed.
But sometimes your stock tells you to hold on.
If your stock rises 20% within three weeks of breaking out from a base or testing its 10-week moving average, you should hold onto that stock for a total of eight weeks, then decide to sell or hold for a longer period. Big winners need time to develop.
The most serious challenge to this eight-week hold rule is the round-trip rule: Don't let a double-digit gain cycle into a loss. Is your eight-week-hold-rule stock turning into a loser after rising more than 10%? Sell.
Such a fast-rising stock is more the exception than the norm. Even among the market's best winners, you'll see a series of 20%-to-25% advances, interspersed with retreats and base-building. Don't think of this as a limit to a stock's potential, but rather as a chance to let it regroup — and perhaps resume its uptrend.
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