[The following is from p.270-272 of How to Make Money in Stocks (4th Edition) by Williams O'Neil (2011). McGraw-Hill.]
Closely related to the decision on when to sell is when to sit tight. Here are some suggestions for doing just that.
Buy growth stocks where you can project a potential price target based on earnings estimates for the next year or two and possible P/E expansion from the stock’s original base breakout. Your objective is to buy the best stock with the best earnings at exactly the right time and to have the patience to hold it until you have been proven right or wrong.
In a few cases, you may have to allow 13 weeks after your first purchase before you conclude that a stock that hasn't moved is a dull, faulty selection. This, of course, applies only if the stock did not reach your defensive, loss-cutting sell price first. In a fast paced market, like the one in 1999, tech stocks that didn’t move after several weeks while the general market was rallying could have been sold earlier, and the money moved into other stocks that were breaking out of sound bases with top fundamentals…
If you make new purchases when the market averages are under distribution, topping and starting to reverse direction, you will likely have trouble holding the stocks bought. (Most breakouts will fail, and most stocks will go down, so stay in phase with the general market. Don’t argue with a declining market.)
After a new purchase, draw a defensive sell line in red on a daily or weekly graph at the precise price level at which you will sell and cut your loss (8% or less below your buy point). In the first one to two years of a new bull market, you may want to give stocks this much room on the downside and hold them until the price touches the sell line before selling.
In some instances, the sell line may be raised but kept below the low of the first normal correction after your initial purchase. If you raise your loss cutting sell point, don't move it up too close to the current price, this will kept you from being shaken out during any normal weakness.
You definitely shouldn’t continue to follow a stock up by raising stop-loss orders because you will be forced out near the low of an inevitable, natural correction. Once your stock is 15% above your purchase price, you can begin to concentrate on the price where or under what rules you will sell it on the way up to nail down your profit.
Any stock that rises close to 20% should never be allowed to drop back into the loss column. If you buy a stock at $50 and it shoots up to $60 (+20%) or more, even if you don't take the profit when you have it, there is no intelligent reason to ever let the stock drop all the way back to $50 or below and create a loss. You may feel embarrassed, ridiculous, and not too bright buying at $50, watching it hit $60, and then selling at $50 to $51. But you've already made the mistake of not taking your profit. Now avoid making a second mistake by letting it develop into a loss. Remember, one important objective is to keep all your losses as small as possible.
Also, major advances require time to complete. Don't take profits during the first eight weeks of a move unless the stock gets into serious trouble or is having a two- or three-week “climax” rapid run-up on a stock split in a late stage base. Stocks that show a 20% profit in less than eight weeks should be held through the eight weeks unless they are of poor quality without institutional sponsorship or strong group action. In many cases, stocks that advance dramatically by 20% or more in only one to four weeks are the most powerful stocks of all – capable of doubling, tripling, or more. If you own one of these true CAN SLIM leaders, try to hold it though the first couple of times it pull back in price to, or slightly below, its 10-week moving average price line. Once you have a decent profit, you could also try to hold the stock through its first short-term correction of 10% to 20%.
When a stock breaks out of a proper base, after its first move up, 80% of the time it will pull back somewhere between its second and its sixth week out of the base. Holding for eight weeks, of course, gets you through this first selling squall and into a resumed uptrend, and you’ll then have a better profit cushion.
Remember, the object is not to be right but to make big money when you are right. “It never is your thinking that makes big money,” said Livermore, “it’s the sitting.” Investors who can be right and sit tight are rare. It takes time for a stock to make a large gain.
The first two years of a new bull market typically provide your best and safest period, but they require courage, patience, and profitable sitting. If you really know and understand a company thoroughly and its products well, you will have the crucial additional confidence required to sit tight through several inevitable normal corrections. Achieving giant profits in a stock usually takes time and patience and following rules.
You've just read one of the most valuable chapters in this book. It should be worth several hundred times what you paid for How to Make Money in Stocks—if you will review and understand what you've read and adopt a disciplined profit-and-loss plan for your own investments. It might even be a good idea to reread this chapter once every year.
