Profit And Loss Plan your portofolio stock

Profit And Loss Plan your portofolio stock

In the Analyzing Stocks section, we discussed the best time to buy a stock. Once you’ve purchased a stock, it’s important that you have a plan to lock in gains and avoid large losses.

Cutting Losses

If you employ the buying strategy discussed earlier and recommend by our founder William J. O’Neil, we recommend implementing a rule to cut all losses on an individual stock at a maximum of 7% or 8% of the initial purchase price to manage risk. No one is right every time they buy a stock. This is your insurance policy to prevent severe losses that will be difficult to come back from. In many cases, you may be able to get out of a poorly performing stock even before it reaches this threshold. If the stock rebounds and breaks out again, you can always buy it back.

It’s important to remember that this rule pertains to your initial purchase price. Once you are up on a stock, you can give it more room for normal fluctuations. The difference is if you are down on your initial purchase, you’re probably starting off wrong. The stock is not acting the way it should after a breakout. If you are already up on a stock, the stock has acted correctly and you have a profit, so you can afford to give the stock some room and not get shaken out by a normal correction.
Timing your buys correctly is an important part of this concept. If you buy fundamentally strong stocks emerging from sound bases in uptrending markets, they won’t often correct more than 8% from your initial purchase price. But if you make a mistake, this rule is there to protect you from severe losses.
Create a portfolio in MarketSmith with just your holdings and check this list daily. You may also want to use the Notes & Discussion Panel within MarketSmith to mark the point on the chart where you will be prepared to cut your loss.

Taking Profits

The best time to sell a stock is when it’s on the way up, while it’s still advancing and looking strong to everyone else. If you wait for a stock’s exact top, you’ll likely be late. You can very easily be caught in the 20% to 40% market corrections that can hit market leaders.

In our extensive studies of the charts of former market leaders, we discovered that successful stocks tend to move up 20% to 25% after breaking out. Then they decline, build new bases, and sometimes continue to advance. If you’re buying breakouts, consider taking many of your profits when you’re up 20% to 25% in a stock. If the stock is forming another base, you can then wait to see if it emerges and offers another opportunity to buy.
There’s a key exception to this. We identified that if in a bull market, one of your stocks surges 20% or more on good volume in just one, two or three weeks from its initial breakout, you could have a big winner on your hands. Set these types of stocks aside and hold them at least eight weeks. At the end of the eight weeks, review the situation and decide if the stock should be held for an even bigger gain.
Again, you may find it useful to use the Markups and Notes & Discussion features of MarketSmith to mark a target zone of when you will first consider taking profits on a stock.