The best defense against a moldering market: a hard and fast sell rule.
Even if you feel sure that your sliding stock will eventually rebound, admit two things. First, the market's direction cannot be predicted; second, you could be wrong about the stock.
Those two facts are why the safest route is to sell any stock that falls 7% or 8% from your purchase price. Follow this rule without exception and in any market condition.
If you sell to cut your losses short and the stock does rebound, you can jump back into it when a new buying area forms. The important part is that your capital lives to fight another day.
Rather than wring your hands and hope for your stock to recover, raise cash and search for leading stocks as they break out of proper bases.
Keep in mind that the larger your loss, the more the stock has to work to erase its loss.
A drop of 25% requires a gain of 33% to break even. If you hang in for a 50% loss, your stock must turn and rise 100%. But if you pull the rip cord at 7%, you only need to make 7.5% on your next investment to rebuild your initial capital.
Slot and video gaming machine maker WMS Industries (WMS) gave investors last year a stern lesson on cutting losses short.
The stock ran up more than 200% from 2009's market bottom and the end of October. Then it dropped in a sharp, two-day sell-off.
Investors who got in at the stock's July breakout owned a wide profit. But those who bought as WMS found support at its 50-day moving average were in a different situation.
When a stock finds support at its 50-day line, the buy point is vague. A lot depends on how volume acts and how the stock bounces off the line. For the sake of this discussion, let's say that you bought at 44.56 the close on Sept. 30 as volume grew.
The October sell-off erased all gains. Some shareholders probably held on, hoping the stock would form a new base. But those who sold could have simply waited for the stock to form a base and break out. If it didn't, they would have left a smaller portion of their capital at risk. As it turned out, WMS continued to weaken.
One more point to remember is that the 7%-8% sell rule applies to your own purchase price, not the ideal buy point.