Consider Sell Rules for Portfolio Security

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Physician's Money Digest, February29 2004, Volume 11, Issue 4

The realproblem:

There are hundreds of ways to select stocks.For example, investors select stocks basedon growth, value, preference, companyknowledge, fundamental factors, technicalfactors, rumors, and even pretty names. One factorthat determines the success of a stock investmentstrategy is the selling discipline. Throughout the historyof the stock market investors have not had a difficult time finding a company to invest in. Over the years, investors have had a difficulttime deciding when to sell their stocks.

Selling is a psychological struggle; it is a decisionthat should be based on concrete and unemotionalrules. Sell rules protect against losses during adversemarket conditions and protect profits during optimalmarket conditions. An investment should never bemade until you have defined the exit point or percentageyou are willing to risk. One example of a stockinvestment method that employs rule-based risk protectionis CANSLIM™. This method protects investmentcapital even after a stock selection has beenmade. CANSLIM™ is an acronym for a number offundamental and technical factors:

Current quarterly earnings per share

Annual earnings increases

New products, new management, and new highs

Supply and demand

Leader or laggard

Institutional sponsorship

Market direction

Winning with Losers

Every investor should protect against potential losses.Many investors pick a stock, only to watch it immediatelyfall in price. In these unfortunate situations, thestock unexpectedly plummets and the investor loseslarge sums of money. Other investors have initial success,but then erase all of their gains with a couple largelosses. This unsuccessful investing philosophy is called"cutting your profits and letting your losses run."Investors should stick with their winners and becomeskeptical of their losers.

CANSLIM™ requires investors to place an initialstop-sell order on their investments. In other words,when an investor invests in a company, they place a sellorder if the stock dips 7% to 8% below the buy point.This makes selling easier and protects investors fromlarge losses or plummeting stocks. Employing a stop-lossorder can save your portfolio tens of thousands of dollars.In addition to the stop-loss rule, CANSLIM™ hasprecise entry points.

Technically Speaking

While investors should base their buying decisionson strong fundamental data, when it comes to selling, it'susually wise to pay more attention to technical factors.Combining fundamental and technical analysis willincrease your probability for success.

Learning when to sell requires understanding dailyprice movements in relation to volume. Daily pricemovements fluctuate between the high and low for theday. This is referred to as the spread. The spread generallytells an investor the amount of resistance to priceprogress. Volume is usually associated with the force ofpower behind a move. Volume in relation to the spreadexpresses the quality of supply (ie, selling) or demand (ie,buying). A few examples of price movements in relationto volume include the following:

  • Increasing spread on increasing volume. Stock isgaining force in the direction of the market.
  • Decreasing spread on increasing volume. Stock ismeeting resistance. Expect a trend reversal.
  • Increasing spread in a declining market onincreasing volume. This usually means increased selling(or supply) during a downtrend.

In addition, if the stock price breaks through significant points of support on higher than average volume,you might want to consider selling. Significant points ofsupport include trendlines, 50-, 150-, and 200-day movingaverages, previous support levels, etc.

Michael Doran is a private money manager affiliatedwith Sierra Capital Planning in northernCalifornia. He runs a fee-based business and ahedge fund for qualified investors. For more information,call 877-467-8657 or visit www.sierrainvestor.com. Christopher Nezbeth also contributedto this article.