Last week, we talked about the 7%-10% sell rule, a strategy that protects investors from bigger losses when their stocks are going down.
Some of you may be wondering: what if the stock starts making a profit? When is the right time to sell?
In this article, we'll learn about another strategy called the 20%-25% profit-taking rule, which tells investors when to sell their stocks and lock in their profits.
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It is crucial for investors to know when to take profits, which secures their gains and avoids potential losses in case the stock price declines later on.
Let's take a look at this example. Cici, a short-term trader, closely follows Netflix's stock (NFLX). Recently, she noticed a rectangular pattern, a series of highs and lows that are relatively equal in value, formed on the stock's candlestick chart. Besides, it broke above the upper trendline, signaling a potential upward movement. Therefore, she bought the stock at $263 per share the day after the breakout.
Just as Cici expected, the stock started climbing and reached $305.6 per share within a few days, a significant increase of 16%. Cici was thrilled and decided to hold onto her shares, anticipating further growth.
However, the positive trend didn't last long. The stock had eight consecutive declines, erasing her profits and even resulting in a slight loss. Worrying about further declines, Cici sold her shares at $255, incurring a 3% loss.
Cici deeply regretted making these decisions. If she had sold earlier, she would have made a 16% profit instead of suffering a 3% loss. This experience teaches her the importance of taking profits at the right time.
Profit-taking means selling a stock when it reaches a certain price to lock in your profits.
There are different ways to make profits in the stock market. One common method is to set a specific percentage, like 10%, 15%, or 20%, as your profit target. When the stock price goes up and reaches that percentage, you sell the stock to secure your gains, which will also boost your confidence in further investment.
But how to decide on the proper percentage to sell? According to William O'Neil, a noted investor and stockbroker, you may consider selling the stock when its price has gone up by 20%-25% from the ideal buy point.
For example, if Cici thinks $100 is an ideal buy point for stock A, she can sell the stock when its price reaches the range of $120 to $125.
Pros: Avoid making emotional decisions; easy to understand and follow.
Cons: Miss out on further gains if the stock continues to rise after you sell.
After a long period of research and practice, William O'Neil discovered that most stocks, especially those with growth potential, tend to rise by around 20-25% after breaking out of a chart pattern. However, they are likely to go through a significant decline afterward and enter a consolidation phase.
Therefore, O'Neil suggests that instead of watching the profits vanish, we'd better lock in our gains before the decline happens.
Some investors might think a 20-25% profit is insufficient, but the advantage lies in the long term. Investors can reinvest their money in new opportunities and gain more profits, which forms a snowball effect.
The 20%-25% profit-taking strategy is based on the scenario of buying at the ideal point. However, in real trading, you may not buy the stock at the ideal price, leading us to a new concept: the actual buy point.
Suppose you think the ideal buy point is $100, but you actually buy the stock at $102. According to the 20%-25% profit-taking rule, your profit-taking range is still based on the ideal buy point ($120-$125), not the actual buy point ($122.4-$127.5).
Therefore, if you exit your position when the stock price reaches the profit-taking range, your actual profit would be around 17.65%-22.55%.
Let's go back to the case of Cici, who bought Netflix at $263. If she traded the rectangular pattern, the ideal buy point would be around $252 above the resistance level. Thus, the profit-taking range would be between $302 and $315, according to the 20%-25% sell rule.
If Cici had followed the rule, she would have sold the stock at $302, earning a profit of approximately 14.8%.
You may wonder what to do if the stock keeps rising after you've booked your profits. Here are some strategies to manage the potential risk of missing out:
If you expect a bullish market, you can sell half or one-third of your position when you reach your profit target, which locks in some profits while retaining the potential to gain further profits.
If you expect a bearish market, consider selling the entire position when you reach your profit target to ensure that you lock in the profits you've made.
Of course, your investment preferences may also impact your strategies. If you're a trend or swing trader, it's essential to set profit targets and stop-loss levels in advance and stick to your plan.
If you're a value investor, consider adopting a long-term investment strategy like Warren Buffett. This approach requires you to understand a company's business model thoroughly and have the patience to hold onto your investment for significant returns.
Remember, the strategy you choose should align with your investment style and risk tolerance.
Selling stocks is an art.
When to sell is even more crucial than when to buy. Once you own a stock, you need to decide whether to hold or sell it.
The 20%-25% profit-taking rule provides investors with a new approach to deciding the selling point.
However, there are other popular strategies for taking profits. You should select the one that suits your circ*mstances the best.
moomoo Learn's premium courses have a lot of advanced investment knowledge, which you are also welcome to explore.
