LOVE – The Selling Guide for Breakout Investors

How to sell your stocks is the biggest question in investing. As legendary trader Jesse Livermore said, “It never was my thinking that makes the big money for me. It always was my sitting.” If you do not have the patience to hold onto the winners, and the resolve to get rid of the losers, you will never get rich in the game.

In the case of breakout investing, where an investor buys a stock at a sound breakout after a consolidation, a holding always falls in one of the following four categories as summarized by the acronym “LOVE”:

• L – Losers: Unsound stocks that falls 7% below the breakout point.
• O – Out-of-Steamers: Lackluster stocks that do not move much.
• V – Victors: Profitable stocks that rise for 20%-25%.
• E – Elites: True winners that gain at least 20% in one month.

According to stock expert William O’Neil, each of them has a specific selling strategy. Below are the details.

L – The Losers

Definition: A “Loser” is a stock that, after a breakout from consolidation, fails to go 10%-15% higher, and then falls back to 7%-8% below the breakout level.

Action: Cut loss by selling it at 7%-8% below the breakout point.

William O’Neil discovers that, after a sound breakout, a stock never falls for more than 8% below the breakout level, so when it does, your timing of buying or selection of selection of stocks usually turns out to be faulty. Investors should be disciplined in taking losses and limit the loss on initial investment in each stock to an absolute maximum of 7%-8%, or even less if possible, like 5%-6%. In this way, you will never let the market beat you, because you always keep your losses small.

O – The Out-of-Steamers

Definition: An “Out-of-Steamer” is a stock that, after a breakout from consolidation, goes horizontally in price, without going 15% higher or hitting the stop loss level in at most 3 months.

Action: Liquidate it and reinvest the money into a better stock.

When you find a winning stock, you must follow up by adding your stake into it, usually at about 2% above your initial buy level. By selling your non-movers and reinvesting into the winners, your capital is deployed more efficiently. You may have to allow 3 months after your first purchase before you decide to remove a dull selection in your portfolio, and this period of tolerance could be even shorter if there already exists clearly better opportunities, or if the market is really strong.

V – The Victors

Definition: A “Victor” is a stock that, after a breakout from consolidation, moves up for 20% to 25% in more than a month, without hitting the stop loss level.

Action: Take profit once the stock has gained about 20% in price.

William O’Neil finds that, after breaking out of a proper base, a successful stock tends to move up 20% to 25%, and then goes into a new period of consolidation. With this in mind, it is usually a good idea to set a take profit level at around 20% above the breakout level. Do not underestimate a small 20% gain each time. Two 20% gains in one year compound into a 44% return, and it could be even more if you are buying on margin.

E – The Elites

Definition: An “Elite” is a stock that, after a breakout from consolidation, makes a 20% gain within a month, without hitting the stop loss level.

Action: Do not take profit immediately, but hold it at least 2 months since it was bought, until a sell signal comes along.

Here is an exception to the 20% profit-taking rule: If the stock is strong enough to rise 20% within a month, it must be held for at least 2 months since it was bought, because very often stocks that advance 20% or more within a month are so powerful stocks that later could be doubling or tripling. Instead of selling them too soon, try to hold the stock pass the first short-term correction since your entry, and see if it can get you through into a resumed uptrend.

During this holding period, do not trail your stop too often, and even if you do, do not move it too close to the current price, for you could be shaken out by a normal weakness. The correct way to trail your stop is, after the first correction is over, putting the new stop at the low of that correction period.

In some unfortunate cases, the price may shoot up 20% very quickly, but then drop all the way back. You should never be allowed to drop back into a loss. It could be embarrassing to buy at $50, watch it hit $60, and then be forced to liquidate at $51, but always remember that capital preservation is the name of the game.

Here are three technical signals, summarized by the acronym “HIE”, that you can rely on when deciding to finally sell them:

• H for “Hysteria”: It refers to an abnormally big buying action of the stock that is usually followed by a sharp drop later. Examples include:
• Climax top: A fanatic buying activity that leads to a month of consecutive weekly increase, and the last up week on the weekly chart often has the largest high-low spread than the previous weeks.
• Overshooting: A breakout on the upside of a rising channel that the price has been staying in on the way up on a weekly chart. It is usually accompanied by a climax top.
• Exhaustion gap: The price gapped higher for more than one day on a daily chart to reach a new high. It, too, is seen together with a climax top.
• I for “Inhibition”: It refers to a heavy volume without further increase in price after a long advance. This usually indicates distribution from large investors.
• E for “Eventide”: Finally, if a stock consolidates in the twilight years of the bull market, and does not move any higher for 3 months, then it is possibly the time to sell.

It is psychologically very hard to sit through all the whipsaws of a winning stock, but making big money requires faith and patience. 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. 

Conclusion

In summary:

1. Buy exactly at the breakout point.
2. The “3-month” rule of holding: sell the stock if it does not go anywhere in 3 months, and transfer to proceedings to better opportunities.
3. The “7-20” rule of selling: set a absolute stop loss at 7%-8% below the buy point, and a profit target of 20%-25% above it.
4. An exception to the profit-taking rule: if a stock is so powerful that it rises for more than 20% in less than a month, then hold it for at least another month until a sell signal comes.

The plan had several big advantages. You could be wrong twice and right once and still not get into financial trouble. And, with some luck, you may happen to hit on some big winners that can bring you financial freedom.