Lessons On Selling Stocks.docx

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Lessons On Selling StocksHow To Sell Stocks To Maximize Your Profits

Buying a stock is only half of the equation. Knowing when to sell is just as important.The first part of this course discusses why it's critical to cut your losses early. Thesecond and third lessons teach you how to spot the best time to sell and take yourprofits, including ways to use stock charts to detect a weakening stock.

These lessons are based on decades of research that continues to this day into theprimary factors that move stocks. These principles aren't based on someone'sopinion or theories from business schools. They're all based on what actually worksin the market.

Lesson 1. Cutting Losses

Selling Stocks To Cut Losses

Cut Your Losses Early

How Cutting Losses Helps You

The 8% Rule Applies Only To Losses From The Purchase Price

Dealing With Hyperactive Stocks

Stop-Loss Orders And Other Considerations

Holding Losers In Your Portfolio?

Key Points To Remember

Lesson 2. Taking Profits

When To Sell Stocks To Take Profits

How To Read Sell Indications From Stock Charts

Relative Strength

Weak Breakouts

Exhaustion Gaps

Learn To Interpret The Market





Lesson 3. Selling Indicators

Reading Key Selling Indicators

Finding Flaws In Company Fundamentals

Industry Groups Tend To Move Together

Flagging Leadership Is Cause For Concern

Selling Clues From Institutional Investors

Stock Splits May Flood The Market


Selling Stocks To Cut Losses

Success in the stock market is as much about limiting losses as it is about riding

winning stocks. A rule-based selling strategy can help you avoid heavy losses and

preserve your portfolio. This lesson explains how to sell when a stock selection

doesn't pan out.

Know When To Fold 'Em

Nobody's right all the time in the market, not even veteran market professionals. But

as the famous investor Bernard Baruch once said, "Even being right three or four

times out of 10 should yield a person a fortune if they have the sense to cut losses

quickly."

Being a successful investor is just as much about limiting losses as it is about riding

a winning stock. Downturns are a part of life in the market, and you must act

decisively to shield yourself from excessive losses. If your stock selection doesn't

work out and you're faced with a loss, don't let your pride stop you from admitting



you've made a mistake and acting quickly. Cut your losses early and move on. You

must make rational decisions, instead of trying to rationalize your way out of a costly

mistake.

It's not just your own personal opinions that can be wrong. Analysts or market

commentators can be just as erroneous, and basing your decisions on their opinions

can often lead to disastrous results. Investors often buy loser stocks, justifying their

decision with remarks like, "All these Wall Street analysts are saying great things

about this company," or "This technology is the greatest thing since sliced bread.

The market doesn't realize it yet, but it's bound to become a household item."

Famous last words.

Cut Your Losses Early

The first rule is sell any stock that falls 8% below your purchase price. Why 8%? Because

research shows stocks showing all the right fundamental and technical factors in place and

bought at precisely the proper buy point (which is explained fully in "Lesson on Charts")

rarely will retreat 8%. If they do, there's something wrong with them.

You may think a stock is due to rebound. But the market could send the stock to lowerdepths regardless of your views or what analysts and commentators say on TV. No excuses,

no alibis. You may want to sell even before an 8% loss if you see other signs of weakness in

a stock.

This rule emphasizes the importance of buying at the right time. If you don't and you buy a

stock that is overextended (that's reaching the end of its climb), chances are it will hit the 8%

sell level as it goes through a normal pullback. Make no exceptions to the rule. The best

stocks will always give you other opportunities to buy. Here's another way to look at it: Oncea stock falls 8% below your cost, does it still look attractive? Is it still among the best stocks?

Probably not. There's no guarantee that it will go back up, and you need to protect yourself.

The bigger the fall, the harder it is to recover. Say you bought a stock at Rs.100 a share. It

falls 20%, to $80. To get back to Rs.100, the stock has to make a 25% gain. Another

example: The stock plummets 50%, to Rs.50 a share. It would take a 100% jump to get it

back to Rs.100 — and how often do you buy a stock that doubles? And if it does, how many

weeks, months or even years does it take to get there? Wouldn't you rather cut your lossearly, and free up money to purchase another stock with better chances of doubling?



Of course, it could happen that you sell a stock that falls 8%, and then watch it go up

afterward. But you have to think of the 8% sell rule as your insurance policy against

catastrophic losses. The rule will in effect limit any losses on your portfolio to no worse than

8%.

Nevertheless, if you've bought a fundamentally sound stock at the right point, (explained in

the stock buying lessons) it will rarely plunge 8% immediately. Buying exactly right will solve

half your selling questions.

How Cutting Losses Helps You

Stock

Shares

Cost/Share

Sell Price

Profit/Loss

%Profit/Loss

A

100

Rs.50

Rs.46

-Rs.400

-8%

B

100

Rs.50

Rs.46

-Rs.400

-8%

C

100

Rs.50



Rs.46

Rs.1,000

+20%

D

100

Rs.50

Rs.46

-Rs.400

-8%

E

100

Rs.50

Rs.46

-Rs.400

-8%

F

100

Rs.50

Rs.46

-Rs.400

-8%

G

100

Rs.50

Rs.75

Rs.2,500

+50%



Total

Rs.1,500

As you can see, even if you had made these seven trades over a period of time — and taken

losses on five of them— you would still come out ahead by Rs.1,500. That's because the

two stocks that worked out resulted in a combined profit of Rs.3,500. And the five losses —

all capped at 8%— added up to Rs.2,000.

You see the point? It would take several 8% losses to wipe out the profit from just one or twogood stocks.

The 8% Rule Applies Only To Losses From The Purchase Price

The 8% Stop Loss Rules Applies Only To Losses From The Purchase Price

The 8% sell rule, however, applies only to drops below your purchase price and does not

apply to situations where you've already made gains on a stock.

Dealing With Hyperactive Stocks

About 40% of stocks pull back close to their buy point for one or two days. This is not the

time to panic and sell, especially if the stock was purchased as it came out of a sound

basing area at the right buy point. (For more on this, check lessons on charts ) As long as

the price doesn't drop 8% below the point at which you bought, you should, in most cases,

hang on through the first pullback.

Watch how the stock performs relative to the general market and its industry group peers.

Often, a stock pulls back close to the buy point for one or two days because the general

market has temporarily pulled back. This is normal. On the other hand, if the market has

been rallying over several days and your stock hasn't come to life, then this might be a

warning sign, even if the stock hasn't dropped 8% below your purchase price.



Stop-Loss Orders And Other Considerations

Some investors like to use stop-loss orders, which are instructions to brokers to sell a stockat a predetermined price. This might be useful for those who can't watch their stocks closely

or for those of us who may be less decisive.

Also, tax considerations and brokers' commissions should rarely enter into your sell

decisions. You shouldn't always hold a stock for more than a year just because you'd pay a

lower tax rate on the profit. And with lower commissions today, they should not be the most

important factor. Your main goal should be to obtain and nail down gains.

Holding Losers In Your Portfolio?

You may be looking at your portfolio and seeing there's some stocks already 8% below your

purchase price— or worse. Should you sell them? Probably yes because as the stock goes

lower it becomes even more difficult to sell. It is easier to sell a stock which is down 8% to a

stock which is down 30%. You feel that the stock can not go lower but feeling has no

significance in the stock market. There is no guarantee it will rebound, and the chances are it

could go even lower. The greater the loss, the greater the chance of it developing into a

really serious loss.


The first sell rule is to get rid of any stock that falls 8% below your purchase price. t's critical to follow this loss-cutting rule regardless of how highly you value a stock.

Personal opinions get in the way of smart selling decisions.

The larger the loss, the higher the recovery you need to get back to the break-evenlevel. (A 50% loss requires a 100% gain to break even.) Strong stocks sometimes initially retreat close to their buy point (as determined by

the stock's chart pattern). This doesn't necessarily mean you have to sell, unless thestock goes 8% below the purchase price.

Avoid making sell decisions based on tax concerns or commission rates.

Lesson 2. Taking Profits



When To Sell Stocks To Take Profits

How do you tell if a stock is at the end of a major price advance? In this lesson, you'll learn

about ways to recognize when a stock starts sputtering and lock in your profits. Chart-

reading skills are a key part of this education.

When To Take A Profit

Let's say you bought a stock and you're watching it go up. At what point do you call it a day

and take your profits?

The sell signals discussed here and in other lessons can occur well before a stock has

peaked. So it's important to learn to recognize critical sell signals. If you regularly review thecharacteristics of stocks that took a turn for the worse, over time you'll be able to quickly spot

valid signals as soon as they occur.

There are several simple selling strategies that have proven beneficial in helping you

consistently lock in profits.

Here's a simple one. Generally, stocks tend to move up roughly 25% to 30% after rising out

of a base. Then they may go through a period of consolidation, when a stock seems to go

nowhere for a number of weeks.

A strategy that safeguards your profits is to sell after you've captured a 25% gain. This is the

conservative approach to profit-taking that works like "building blocks." Once you sell and

take a 30% gain, compounding it with other 25% profits taken during the year should net you

very substantial gains overall. This gets back to one of the basic tenets of investing: The key

to being really successful is to capitalize on your strongest stocks.

The 25% profits will also outweigh any mistakes you make in stocks that start to take a

nosedive if you also cut losses at 8% (see Lesson 1, "When To Sell Stocks To Cut Losses.")

These two strategies alone could help you become quite successful in the market.

There's an exception to this rule, however. If a stock races up 20% in one to three weeks out

of a proper base, it probably means it has plenty of fuel left and you should hang on to it. It

may be your best stock. And always review the market conditions. In a strong market, you

will see this situation often.

The shorter the trip to the 25% level, the stronger the stock.



How To Read Sell Indications From Stock Charts

Often, the most important sell indicator is the stock's price and volume action as shown on achart. Many times, stocks break down their upward trends before any negative signs emerge

from fundamentals, such as earnings, sales, profit margins or return on equity. The following

indicators can flag weakness in a stock and can be observed with the aid of Charts.

Volume Clues

If a stock's price falls persistently on heavy volume, it usually signals a shift in professional

investor sentiment in which sellers predominate, making any price advances more difficult.

Another red flag is a stock making new price highs on lower or poor volume.

Price Clues

The number of consecutive down days in price vs. up days will likely change and increase

once a stock begins falling from its top. For example, a stock will close lower five days,

followed by two days closing higher, compared to an earlier pattern of five days up and then

two down.

Churning

After a substantial advance, the stock's trading volume increases but its price doesn't move

up much for several days. This is called churning, or heavy volume without further price

progress.

Relative Strength

Sometimes sales numbers mask problems at companies. Companies may rely on just a

handful of customers, and losing any of them may mean big trouble. Other companies are

overly reliant on overseas markets, putting them at risk of bad economies or political strife

abroad. Also, fluctuations in foreign-exchange rates can seriously dilute sales figures. Some

companies, such as pharmaceuticals, get the bulk of their sales from a few flagship products.

If sales in these items falter, it could mean more trouble than if the overall sales drop. With

retailers, additions of new stores increase the sales figures, even if sales at existing stores

slow down. That's why retailers report total sales as well as same-store sales, to provide anapples-to-apples comparison. Another pitfall happens when companies include sales that



haven't actually taken place. Orders that won't be shipped or paid until weeks or months

later sometimes are added to the sales total to inflate results. Also many a times the sales

increase because of the price inflation and not actual demand, typical in commodity

companies. Therefore price increase should be sustainable and not just a one time

temporary phenomena.

Moving Average Lines

Pay close attention if the stock's price closes below the 50-day moving average. The 50-day

moving average is generally regarded as a stock's possible price "support" level. It may not

mean much when a stock dips below this level, but when it closes several weeks below the

50-day line, unable to rally, it suggests investors are abandoning the stock. Also worrisome

is a 200-day line that turns down

Weak Breakouts

The stock breaks out of a basing chart pattern, but weekly volume is less than the week

before, or volume is less than 50% above the stock's average over the past 50-days (The

average volume is illustrated by the line moving across the volume bars.) This indicates

lukewarm interest at a pivotal point for the stock, and it could later become a failed breakout.

Climax Tops

The stock, after a strong run-up for several months, reaches a "climax top" in which the price

suddenly goes up even faster — 25% to 50% or more on heavy volume in a couple of weeks.

The price spread for the week will be greater than on any prior week since the beginning of

the stock's major move. Sometimes this run will culminate with the stock's largest single-day

advance since it began moving up. As the name implies, this is a situation when a buying

spree in a stock becomes too obvious and everyone is excited by the price action. When it's

obvious and exciting, it's too late — sell into the euphoria.

Exhaustion Gaps

Some climax runs will end with an "exhaustion gap," which happens when a stock that has

been advancing rapidly and is greatly extended from its base opens at a price above the

prior day's highest level. This usually indicates the final stage of its move — one final burst

of buying before a stock eases back. However, when this happens close to the breakout, it iscalled a breakaway gain, and it can actually be a sign of strength.



Late-Stage Bases

As a stock advances, it builds several bases. The third or fourth base, however, is more

prone to a decline. This is common among leading stocks. During the first base, the stock

demonstrates inherent strength, but few investors notice it. When the second base forms,

more investors notice it. By the time the third or fourth base forms, however, almost

everybody notices it, including most of analysts, brokers as well as dealers. That, oddly

enough, is historically the time when the stock is most likely to sputter.

Learn To Interpret The Market

One of the most important selling rules applies not to individual stocks, but to the market as

a whole. You may be right about your stocks, but if you're wrong in your assessment of the

general market, your stocks will suffer. During a market decline, even good stocks have a

hard time swimming against the market's current. Typically, three out of four stocks go down

in a declining market.

The market always begins a downturn with a series of distribution days in which selling

predominates. Over the course of a few weeks, at least one of the major market indexes (the

Sensex or the Nifty) closes lower or stalls several times on higher trading volume than the

prior day. This is another example of churning, and every major market downturn has begun

with one such episode.

Also during weakening markets, the leading stocks (those that have led the market's uptrend)

typically start to falter.

When the market enters a confirmed downturn after four or five days of clear distribution in a

market index, you're better off selling some of your stocks and raising some cash. Get off

margin (that's when you borrow from your broker to buy stocks) at once. Sell your worst

performing stocks first. Of course, you'll need to keep watching the major market averages

to identify the market's next turn. You may see the market rally for a few days, only to falter.

Learn to recognize a valid market upturn so you aren't misled. Always regard the 8% Sell

Rule (selling any stock that falls 8% below your purchase price) as your safety net,

particularly in market declines. Track signs of weakness in both your stocks as well as the

general market.

But we have already done the hard work for you. Market Direction is presented in the Market

Analysis section.To avoid serious damage take the pain to read the 'Market Direction' daily.



Key Points To Remember A simple, clear-cut strategy is to sell after your stock has gained 25%, unless the

stock has gone up 20% in just one to three weeks. Stock charts are especially helpful in spotting signs of weakness in stocks, often

providing clues much earlier than any fundamental indicators show. Look for climax runs, exhaustion gaps, failed breakouts, significant violations of the

50-day moving average and other characteristics of a weakening stock. Remember to check the market direction daily. If the market comes under

distribution and weakens, your stocks will have a hard time making any furtheradvances

Lesson 3. Selling Indicators

Reading Key Selling Indicators

Just like stocks flash signals before making huge gains, they can also show certain

characteristics that indicate potential trouble. In this lesson, you'll learn to identify the

warning signs of a weakening stock.

Sell Signals Aren't Always Obvious

If sales growth starts to slow, does it really mean trouble for a company?

If the leading stock in an industry group sputters, does it spell a similar fate for other stocks

in the group?

And must you always sell if earnings are disappointing?

For investors, these questions are just as challenging as finding the right stocks to buy.

Sometimes, stocks can fool you. They peak on seemingly the best days, when financial

magazines rave about them, and shareholders are bubbling with excitement.

But some of the same tools that indicate the potential for a stock to go up, can also tell you if

a stock is headed down. This lesson will help you isolate the most useful fundamental

indicators. But keep in mind that a stock's price and volume action is also valuable in

spotting sell signs. Many times, a stock's chart will reveal something wrong with a stock

much earlier than fundamental factors



Finding Flaws In Company Fundamentals

If you want clues to a stock's decline, you can basically take all the financial indicators thatdrive a stock up— such as earnings growth, sales growth and profit margins— and turn

them upside down. These are your red flags:

A sharp slowdown in earnings growth in back-to-back quarters. For example, if a company's

earnings growth has been in the 100% range for several quarters, it's bad news when that

slows down to 20% or 30%. The street has little patience and will quickly turn its attention to

other, faster-growing companies. You should also pay attention to companies whose

earnings or sales growth break a habitual pattern. For example, if a company had earningsgrowth over several quarters between 25% and 35% then reports three quarters of steady

deceleration, this could be a red flag. Such subtle slowdowns in earnings or sales can

sometimes lead to the company eventually missing earnings forecasts.

Significant drops in other main fundamentals— sales growth, profit margins and return on

equity— should serve as warning signs, especially if the stock starts having trouble making

gains. Check the Sales+Profit Margins+ROE Rating for any significant drops in this gauge.

Industry Groups Tend To Move Together

When the majority of best-performing stocks in an industry fall sharply on heavy volume and

are unable to recover, typically other stocks in the same industry could become vulnerable.

For example if ICICI Bank or State Bank of India is falling sharply on heavy volume, the fall

of the other banking stocks could be on the cards

Flagging Leadership Is Cause For Concern

One of the best ways to tell if a stock might go higher is by how it's performing already.

When a stock no longer outperforms its peers, it's telling you the road will probably get

bumpy. You can tell exactly how a stock is performing with the Relative Price Strength. Your

stock should better than its pears.



Selling Clues From Institutional Investors

The buying activity by mutual funds and other institutional investors is a huge influence on

stock prices. Just as it's wise to buy stocks funds are buying, you might in certain cases

consider selling stocks the funds are selling. Professional selling can be witnessed on the

charts when stocks fall on heavy volume. One can also see the institutional holding in the

shareholding pattern published every quarter on the websites of BSE and NSE.

Stock Splits May Flood The Market

Stock splits are when a company increases its shares outstanding and the share price is

adjusted accordingly. For example, XYZ Corp. sets a 2-for-1 split of 100 million shares

trading at Rs.50 each. After a split, there are twice as many shares, or 200 million, trading at

Rs.25. Companies do this to lower the share price in hopes of drawing more investors into

the stock.

But too many splits can have the opposite effect. Adding shares can tilt the supply-demand

equation because there's a bigger supply of shares to go around. The stock price could fall.

Carefully watch any stock that has split more than once in the past 12 months. Consider

selling if a stock runs up 25% to 50% for one or two weeks on a stock split. However, a few

hyper-growth stocks have kept climbing despite more than one split a year.


Consider selling a stock if it shows fundamental signs of weakness, such as a steadydeceleration in earnings or sales.

Watch for weakness in the stock's industry group. When the leading stocks in anindustry decline, the other stocks in the group may typically go down, too.

If there are signs that mutual funds are consistently selling the stock, you shouldconsider selling.

Too many stock splits close together in time can push a stock lower

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