The 7% sell rule is a fundamental principle for selling stocks that states that you should sell a stock if and when it falls 7–8% below the price you paid for it. This rule is based on a study of over a century of stock market history, which found that even the best stocks will sometimes drop slightly below their ideal buy point but typically do not fall more than 8%. In this article along with the whys and hows of selling a stock, we’ll share some rules of selling stocks. We’ll also discuss a major recent example of why the 7% sell rule is always valid.
Why Sell Stocks At A 7%-8% Loss?
The 7%- 8% sell rule is based on our ongoing study of more than 120 years of share market history. Even the best stocks will sometimes break out and quickly fall slightly below their ideal buy points. But when they do, decades of history show that these leaders do not typically fall more than 8% below their proper entry prices.
If your stock does decline more than 8% below the ideal buy point, it usually means something is wrong with your chosen entry point, the company, industry, stock market indexes, or all of the above. Sometimes, you’ll know the reason. Other times, you won’t. But the stock is dropping, and you’re sitting on a 7%-8% loss. You must immediately shift into capital-preservation mode and cut that loss short.
Like having insurance to safeguard against severe damage, this one simple rule for when to sell stocks is there to protect you from a potentially crippling loss. You can limit your loss to 7% to 8%, and sell the stock because once a stock plunges, there’s no telling where the bottom is.
If a truck is barreling toward you, you wouldn’t stand there and wonder why the driver isn’t slowing down. You’d get out of the way. Your top priority is to preserve capital. Sell first, ask questions later.
Rules Of Selling Stocks
It’s easier to be objective when deciding what stocks to buy. Before investing money, you can use stock lists, a stock screener, and ratings to identify the best stocks to buy and watch.
But the psychology changes once you own shares and have skin in the game.
Emotions of greed for significant gains and fear of big losses kick in. These emotions can cloud your decision-making, making it more challenging to keep an unbiased, objective look at when to sell stocks you own. To stay grounded and in the right mindset, keep these rules in mind.
Everyone makes mistakes. Just be sure to cut all losses short. Even the best investors get hit with a loss from time to time. But they don’t indulge in worry as the stock drops even further. They cut their losses quickly and move on. Leave your ego and pride at the door. Don’t let a loss get to you either mentally or financially.
If you don’t sell early enough, you’ll have to sell too late. To lock in solid gains, sell while your stock is still growing. Your goal is to make and take significant gains and not get excited, greedy, or emotionally carried away as your stock’s advance strengthens. Following the 20%-25% sell rule will help you do that.
Have a selling plan in place before you buy. The real drama kicks in when it comes time to sell. If you need to sell rules and an exit plan to guide you, it’s easy to freeze and not take action when necessary. If your stock soars, you might get greedy and ignore specific sell signals and warning signs.
If you’re sitting on a loss, you may do the “hold and hope” routine, praying it bounces back — while it continues to drop. Stay grounded and keep your emotions at bay by having a selling plan ahead of time. Write down your target sell prices for both taking profits and cutting losses.
Don’t refrain from letting a decent gain turn into a loss. If you have a nice gain of 10%, 15%, or more, and the stock begins to decline, don’t let that profit disappear completely. It’s much less frustrating to see a 15%-20% gain turn into a 5%-10% profit than to see it turn into a 10% loss. You can always repurchase the stock if it shows renewed strength and forms a proper buy point.
Don’t marry your stocks. Although, you can date them! In most cases, it’s better to make a good profit while you have it. Never hesitate to separate and protect yourself from a bad relationship if there are clear signs or red flags of trouble.
Sell your losing stocks first. When building a winning basketball team, you wouldn’t trade away all your top players for a bunch of benchwarmers. Yet many investors do just that. They sell stocks with a good gain and hold those showing a loss, thinking a significant increase is just around the corner.
That’s usually just wishful thinking. Do the opposite. Sell your losers and use that money (if the market trend is favorable) to add winners to your roster or invest more money in the top performers you already own.
When buying a stock, focus on the fundamentals and the stock chart. When selling, focus on the chart. They say the view is excellent at the top, and that often applies to stocks as well. The warning signs typically appear in the stock chart (i.e., technical analysis) before appearing in the company’s fundamentals.
So, while it’s crucial to use technical and fundamental analysis when buying stocks, when deciding when to sell stocks, focus on the chart and technical analysis, like the price and volume action and behavior around key moving averages.
The most crucial selling rule is to buy at the right time. Buying at the wrong time is a widespread mistake, particularly for beginner differentiators. Some will not pay attention to market timing and buy during a market correction when most stocks go down. Or they’ll ignore the technical action in the stock chart and either buy too soon or too late.
So before buying a stock, ensure three key factors (market trend, significant earnings driven by something new, and institutional support) are in place. Doing that will help ensure you get in at the right time with the odds of success squarely in your favor.
The Meta Story
The 7% sell rule is one tool that small investors possess and larger funds that hold massive positions among a wide range of stocks may not possess.
Meta Platforms (META) Shares broke out of a flat base with a buy point of 377.50 on Aug. 30, 2021. Volume was lower than average, which should have alerted a watchful investor. Shares rose to 384.33 but quickly started to fall.
The stock fell below its 50-day average on September 20, 2021, this was the first sign of trouble. That same day, Meta’s dropped as low as 349.80, more than 7% decline from the buy point. Two days later, the stock gapped down, and the 7% loss was quite clear by now. Shares plummeted to 88.08 by November 2022, a loss of 77% from the August 2021 entry.
Meta didn’t return to its August 2021 levels until the start of 2024. Investors holding on to its shares from the sell signal would have waited more than two years to return to break-even. But those who sold in September 2021 would have the capital to reinvest in the stock for its 2023 rally.
FAQ
Q. What is the 7% stop-loss rule?
If the stock falls 7% or above, from the entry price, it triggers the 7% sell rule. It is time to leave and exit the position before it becomes any worse. This way, investors can stay in the game for future opportunities by saving capital. The deeper a stock falls, the harder it becomes to break even.
Q. What is the 3 5 7 rule in trading?
A risk management principle known as the “3-5-7” rule in trading advises diversifying one’s financial holdings to reduce risk. The 3% rule states you should not risk anything more than 3% of your trading capital on a single deal.
Q. What is the 90% rule in trading?
According to this rule, 90% of novice traders will experience significant losses within their first 90 days of trading, ultimately wiping out 90% of their initial capital.
