How to Recognize Sell SignalS Sell Rules: Signs of Weakness · ten look their best as the stock...

How to Recognize Sell SignalS

Sell Rules: Signs of Weakness

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How to Recognize Sell Signals

Sell rules are critical to your success in investing. Too many people allow feelings to dictate their actions, which can lead to giving away much of your hard earned profit, or even worse, incurring heavy losses. Proven sell rules keep your emotions in check and help you maximize your profit when you do pick the right stock.

Our number one sell rule is you must sell a stock if it goes 7-8% below your purchase price. This is your “insurance policy” against a cata-strophic loss. Letting a loss increase beyond this point makes it incred-ibly difficult to recover. Another big sell rule that is often overlooked is buy your stocks properly in the first place. Chasing a stock when it is extended more than 5% or 10% from a proper buy point, or pyramiding improperly and getting your average cost too high, puts you in peril of getting shaken out of the normal corrections a stock will go through during its run.

You will notice that few sell signals have anything to do with the earn-ings, sales or other fundamental analysis of the company. Remember the market is a forward looking mechanism. The fundamentals can of-ten look their best as the stock peaks and won’t show signs of weak-ness until months later. You will most often rely on your chart analysis to determine when a stock has topped, rather than the fundamentals.

In our last booklet, we discussed how to sell a stock on the way up while it is still acting strong by recognizing climax top signals. In this booklet, we will examine signs of weakness that can occur near the top and as the stock starts on its way down. While a stock’s descent may happen very quickly, it usually doesn’t happen without warning. You will often see multiple signals that your stock should be sold - some early and some late. With each new signal giving you more conviction the stock should be sold. Your job is to learn to recognize those signals.

Lock In Your Profits – Recognizing Signs of Weakness Signs of distribution: Pay particular attention when the weekly volume for a stock is heavier than the week before and the price closes down or up just slightly. I call this heavy volume without further price progress up, and it is a sign that institutions may be selling the stock.

Signs of a poor rally: When heavy volume at the top is followed by an attempted recovery on lower volume, this can be a final chance to get out of the stock near the top.

New highs on low volume: This means that there is a lack of institu-tional demand for the stock at that price. If the institutions won’t buy it, how will the stock continue its run?

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Closing at or near the price low: When you see a number of days, or weeks, that close at or near the low of the price range, fully retrac-ing the stock’s advance, it suggests that the stock is unable to hold its gains and that sellers are gaining the upper hand. On a stock chart it looks like “arrows” pointing down.

Late-stage base: A stock breaking out of a third- or fourth-stage price base on the way up should be viewed with suspicion. At that point the stock has become more obvious to the masses. What is obvious, seldom works in the stock market.

Lagging Relative Strength: Using charts makes it easy to see when your stock is underperforming the general market. You will observe the relative strength line down from its previous peak. While it is normal to see temporary downtrends in the relative strength line, when the stock is going to new high territory with a lagging relative strength line, this is a warning the stock is probably no longer a leader.

To really improve your selling strategies, always do a post-analysis on your trades. Study any mistakes carefully to determine if there were signs that you missed or ignored. A post-analysis can help you identify your personal weaknesses and help you lock in even better gains in the future. I’ve been investing a long time and post-analysis still helps me be a better investor.

As always, you can see more educational examples in Investor’s Cor-ner in IBD®. Plus, visit our web site, Investors.com, to view more sam-ples in the Education section and the Daily Stock Analysis video.

The chart on the next page gives you definitions of key features includ-ed in IBD chart examples. You can use it as an additional reference as you go through this booklet.

We look forward to helping you become a more successful investor.

William J. O’Neil

P.S. Remember, every investor needs sell rules

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Copyright © 2009 Investor’s Business Daily, Inc. All rights reserved

Weekly ChartThe Limited Increased 467% in 135 Weeks

Relative strength line is below previous peak as stock makes new price high

Average weekly volume line

200-day moving average line

10-week moving average line

Weekly volume bars

Relative Price Strength Line vs. S&P 500. Uptrending line means stock is outperforming S&P 500.

Stock splits

High

Low

Close

Thin gray line means stock closed at a lower price than prior week’s close

Thick black line means stock closed at a higher price than prior week’s close

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Alliance Semiconductor Increased 539% in 47 Weeks

Stock tries to rally but volume is lower than prior week and price stallsNext 2 weeks are down weeks on increasing volumeAnother rally attempt on lower volume than prior weekA bad break on higher volume

Weekly Chart

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Apple Increased 1418% in 199 Weeks Weekly Chart

Volume increases on down weekNew high on lower volume than prior weekAnother volume increase on down weekNew high on lowest volume in over 6 monthsA bad break with 4 down weeks closing near lows with each week increasing in volume

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Precision Castparts Increased 259% in 115 Weeks Weekly Chart

Down weeks on higher volume than prior weekStalling action - Volume increases from prior week without further price progress

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Intl. Business Machines Increased 400% in 161 Weeks

5 down weeks with a pickup in volume show institutional sellingThis is a failed breakout - price is down on week following breakout and volume is heavier than breakout week. After an extended move, breakout failures often signal a top

Weekly Chart

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Pic ‘N’ Save Increased 546% in 206 Weeks Weekly Chart

Arrows show where price closed down on volume heavier than prior week Reverses from new high territory on much heavier volume than prior weekBreakout into new price high with volume lower than prior week and below average Poor rallies - volume declines as price moves up

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10 Copyright © 2009 Investor’s Business Daily, Inc. All rights reserved

E M C Increased 1204% in 139 Weeks

Price trend is up but the volume trend is down - this is a weak volume rallyDistribution weeks - volume is higher than prior week and higher than average while price declines

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Gilead Sciences Increased 218% in 175 Weeks

Breaks out into new price highs on lower volume than the prior weekPrice trends higher but volume trends weaker - a weak volume rallyArrows show distribution weeks where price is down and volume comes in higher than prior week

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Liz Claiborne Increased 237% in 43 Weeks

Breaks out of a third-stage base. Late-stage bases are more failure proneHandle should drift down rather than wedging action shown hereMore wedging action before breaking out into new price highsNew price highs are made with each week’s volume lower than prior weekPrice is down and volume comes in higher than prior week as stock breaks down

Second stock split in 9 months

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D S C Communications Increased 945% in 59 Weeks

Arrows show distribution weeks where price is down and volume comes in higher than prior week

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Weekly Chart

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American International Group (AIG) Weekly Chart

There was no reason to be caught in AIG when it was the epicenter of the financial crisis in 2008. There were multiple sell signals in 2007.

Persistent institutional selling - down weeks on heavier volume Attempted rallies come on decreasing volume

Relative strength line had been lagging for years

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