Buying a stock at the right time is easier than figuring out when to sell stocks. But letting a winner ride can backfire, as some Amazon stock investors found out.
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That’s where the 20% to 25% profit-taking rule comes into play. If a stock you own goes up more than 20% from where you bought it, that’s a good time to consider locking in some gains.
You’re probably wondering: What if the stock still has legs and gains 50% or 100%? Why should I unload any shares if the stock isn’t sending any other sell signals?
Fair questions, for sure. But experience and years of research suggest the 20% to 25% level is often the perfect time to take profits. By locking in gains, investors eliminate the potential risk of losing a 20%-plus gain.
You might not get that double or triple, which are hard to come by. But you can generate solid returns by taking 20% to 25% profits in several stocks — and limiting downside losses to 7% or 8% from your purchase price.
Also keep in mind: If the stock sets up a new valid buy point, you can always buy shares again.
Using The Profit-Taking Rule
When the market is in a confirmed uptrend, think about selling some of your shares. This way, you can take partial profits off the table and find out if the stock’s run still has some legs.
But when the market is in a correction or the market uptrend is under pressure, selling your entire position at 20% to 25% makes sense. The risk is greater during such times, so why not lock in gains while you can?
IBD founder William O’Neil developed this rule after studying winning stocks for years. Most stocks corrected sharply in price after a 20% to 25% advance from a proper breakout. So, he learned to sell stocks on the way up.
Amazon Stock Sends Warning Signs
Take Amazon.com (AMZN) as an example. The stock first cleared a 1,617.64 buy point of a six-week cup base in heavy volume the week ended April 27, 2018 (1).
It drifted slightly below and above the entry over the next few weeks, but went on to rise nearly 27% by its early September peak (2). Investors who held on in hopes of further upside would instead see Amazon stock trigger two sell rules.
In October, the stock fell sharply below its 10-week moving average in heavy trade (3). And in mid-November, it erased the entire gain from the buy point, tripping the round-trip sell rule (4).
So investors could have locked at least a partial profit of 20% or more. Or, they might have watched all their gains evaporate in two months.
Eight-Week Hold Rule
There is one exception to the profit-taking rule, which applies only when the market is in a healthy uptrend. If a stock rallies 20% or more in less three weeks after breaking out from a sound base, hold it for at least eight weeks. Then reassess when the hold period is over.
“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.”
Follow Nancy Gondo on Twitter at @IBD_NGondo
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