To become a successful investor, you need to have rules and the discipline to follow them. IBD readers may already be familiar with the golden rule of selling: cut losses at 7%. But when do you take profits?
In short, take at least some profits when a stock gains 20% to 25% from the buy point. IBD founder William O'Neil crafted this rule in 1961, when he noticed that after stocks break out of well-formed bases, they tend to run up 20% to 25% before correcting again.
This is your default guideline for profit-taking and you should not deviate from it without careful consideration. When combined with the 7% stop loss rule, this rule offers a huge advantage to investors. You can be wrong twice and right once and still come out ahead.
How To Invest: Exception To The Rule
When your stock hits the 20% to 25% profit zone one, two, or three weeks after a breakout, it should be held for at least eight weeks. This is known as the eight-week-hold rule.
"Those could be your big leaders and should be held for a potentially greater profit," O'Neil wrote in "How to Make Money in Stocks." With such explosive stocks, this helps investors get through an expected selling squall into a resumed uptrend with a better profit cushion.
In a choppier market, you may find stocks are not making 20% to 25% gains. You can only manage to get between 10% and 15% profits. If the market is reducing potential gains, you must also reduce potential losses. Adjust your stop losses to 3% to 5% to compensate. The goal is to stay within that 2-to-1 ratio.
How To Invest: Don't Get Greedy
Google parent Alphabet formed a cup base in September and October 2020, its first since pandemic lows. Its climb would be steady, forming a series of bases with gains of less than 20% from each breakout.
Alphabet finished another flat base in June 2021 (1). It was already up 10% from the buy point when it reported Q2 earnings (2), extending its advance.
With EPS up 191%, Alphabet maintained its "Three Quarters of Accelerating Earnings" flag in IBD MarketSurge. This is a bullish designation that identifies bullish growth.
With earnings nearly quadrupled, GOOGL had regained its confidence if just barely. It finally squeaked out a 20% gain in the first week of September (3). Now, the heart was out of the melon.
The stock started forming a new base at that time, making it an ideal time to take profits.
Its next two bases failed and Alphabet dropped nearly 45% from its highs.
As O'Neil would say, "The secret is to hop off the elevator on one of the floors on the way up and not ride it back down again."
This article was originally published July 7, 2023, and has been updated.
