This Mistake Could Cost You a Fortune

Frankly, I thought it was impossible -- that there was no way this could happen again and again and again. But then, sure enough, it did.

It's not what you think!
You might be assuming I'm talking about watching my shares of rock-solid businesses like Apple (Nasdaq: AAPL  ) , Caterpillar (NYSE: CAT  ) , and Freeport-McMoRan (NYSE: FCX  ) drop day after day after day this time last year -- sometimes by double-digit percentages

But I'm actually referring to something much more painful for me personally: watching my beloved Oklahoma Sooners blow it year after year after year in the big dance.

You see, my grandfather played football for Oklahoma, and I've been a Sooners fan since I was old enough to walk. So it was nothing short of devastating to watch Oklahoma lose its fifth straight BCS bowl game -- and its third straight national championship game -- to Ol' Tim Tebow and team.

Of course, I'll always be a Sooners fan, even though they're now the Buffalo Bills of college football. After all, in sports, sticking by your team through the ups and the downs is a virtue. Just ask any Green Bay Packers fan.

Wall Street is a different ball game
For proof, just ask any longtime "fan" of:

Stock

10-Year Return

Hartford Financial (NYSE: HIG  )

(43%)

Eastman Kodak (NYSE: EK  )

(91%)

Ambac Financial (NYSE: ABK  )

(95%)

Freddie Mac (NYSE: FRE  )

(96%)

Data provided by Yahoo! Finance.

Or ask my fellow Fools Rich Greifner or Adam "The Wied" Wiederman. Or even ask Jim Cramer. In his book Real Money, Cramer reminds investors, "This is not a sporting event; this is money. We have no room for rooting or hoping."

Yet it happens all the time. Investing message boards are full of desperate investors who hope some cash-rich behemoth will come along and save their decades-old American superbrand. But as Circuit City investors found out, this is often a losing bet -- especially in this credit-strapped market.

Others ride stocks all the way into the ground because they're emotionally attached to the company's story, products, or management -- and meet with similarly dismal results. Take Crocs investors as an example.

Ditch that loser!
One of the "20 Rules for Investment Success" from Investor's Business Daily is to "cut every loss when it's 8% below your cost. Make no exceptions so you'll avoid any possible huge, damaging losses."

To a sports fan, that advice might seem cruel and unusual, but it's actually good investment advice. Or is it?

To find out, I dug through David and Tom Gardner's Motley Fool Stock Advisor picks. They often rerecommend a stock even after a big run-up -- or a sharp fall. I actually found two examples where breaking IBD's rule actually paid off big-time:

Stock Advisor Pick

Decline After
Recommendation

Gain After
Re-Recommendation

Netflix

23%

229%

Quality Systems

14%

1,000%

These weren't flukes, either
In his re-recommendation write-up for Netflix, David Gardner admitted, "We're currently sitting on a 23% loss." But he went on to say, "I think this is one cheap stock at $11, backed by a great management team that's going to create value for us going forward."

Note that he had well-thought-out reasons for owning the stock: "It remains first and best in a growing industry, creates convenience for millions of consumers, and is led by visionary management that markets aggressively." Netflix stock has risen 229% since then.

So when do you sell?
In today's market climate, IBD's rule probably looks like pure genius -- and it probably could have saved you a lot of pain last September.

In the process, though, you might have had to sell every stock in your portfolio (I certainly would have) and you may well have set yourself up to miss out on some truly massive gains as the market rebounded.

When it comes to knowing when to sell, investors have drastically different strategies. Many have hard-and-fast numerical rules -- which is at least part of the reason we saw many excellent businesses losing 5% or even 10% per day late last year.

Others -- like the Gardners -- stick to a more analytical and intellectual approach to determine when to recommend that their Stock Advisor subscribers sell a stock. So when do David and Tom Gardner consider dumping a stock? Primarily when they encounter:

  • Untrustworthy management.
  • Deteriorating financials.
  • Mergers, acquisitions, and spinoffs that could damage the business.

The debate rages on
Someone once said, "I have no problem knowing when to buy a stock, but if I just knew when to sell, I'd be a great investor."

Investors may never agree on when or why to sell a stock. That's why it's important to have an emotionless, well-thought-out strategy in place. If you don't, you may suffer major losses or miss out on massive gains.

I didn't end up selling Apple, Caterpillar, or Freeport-McMoRan because I believed in the long term potential of each business. In fact, I loaded up on each to reduce my cost basis, and one year after those massive daily drops, I'm back in the green.

For what it's worth, David and Tom Gardner rarely sell either, and it works for them. Even in this tough market, their average Stock Advisor pick is performing more than 36 percentage points better than a like amount invested in the S&P 500.

Now, I challenge you to use the comment box below this story to tell us what your strategy is, and how it held up through the brutal bear market.

And if you're curious to see what David and Tom are recommending now -- including their top two picks for new money -- you can join them at Stock Advisor absolutely free for 30 days.

In addition to all of the stock picks and research, you'll also get full access to exclusive members-only discussion boards, where you can swap thoughts about when to buy or sell a stock with thousands of other dedicated investors.

To learn more about this free, no-obligation 30-day trial, simply click here.

Already subscribed to Stock Advisor? Log in at the top of this page.

This article was first published Dec. 28, 2007. It has been updated.

Austin Edwards owns shares of Apple, Caterpillar, and Freeport-McMoRan. Apple, Netflix, and Quality Systems are Motley Fool Stock Advisor picks. Both the Fool's disclosure policy and Sam Bradford will be around for at least another year. Unfortunately, so will Tim Tebow.


Read/Post Comments (8) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 06, 2009, at 5:17 PM, Fool wrote:

    I was hopping to learn when to sell from you article....

  • Report this Comment On September 06, 2009, at 6:24 PM, tree7 wrote:

    ditch what loser?

    i did not give anyone permission to touch any of my accounts...

  • Report this Comment On September 06, 2009, at 6:40 PM, jcwilkie wrote:

    First commenter sounds like he wanted to be misguided.

  • Report this Comment On September 07, 2009, at 9:23 PM, NeophyteNob wrote:

    I don't sell. No one knows when the right time to sell it. If I need the cash, I sell. If I don't, I let it ride. I jumped in to the market when all the experts said it wasn't time. Guess what? I've made over 100% on my money over the last couple of months. I think those who stick it out are going to be happy for the next few months anyway.

  • Report this Comment On September 07, 2009, at 9:49 PM, lhotrod11 wrote:

    NeophyteNob in my opinion is right. No-one really knows when to by or sell unless you get one of those letters warning you of insider trading after the fact. Not all of our picks will work but in this market many of us will do better than the dart throwing $750,000 per analyst of the late 90's

  • Report this Comment On September 08, 2009, at 9:28 AM, primescot1 wrote:

    first boise state, NOW BYU, where is barry switzer when you need him......

  • Report this Comment On September 08, 2009, at 10:55 AM, govtgrant wrote:

    All these guys want to do to is get you to buy their newsletter. I can tell you I made 400% on a stock, go find one that did and publish the "if you listened to me then" newsletter. Good Grief

  • Report this Comment On September 08, 2009, at 3:26 PM, jjvors wrote:

    This is a pretty good article. The summary key is, know WHY a stock is declining. Bad management? Bad sector? Bad economy?

    They didn't mention dividends evither. You can still make money on a declining stock if they pay high dividends--and they will continue to do so. Again, you must know the company. Are they conservative? Have they been over sold by momentum dealers? Is the sector out of favor? Do they generate cash flow to continue the dividends?

    Finally, they didn't mention that selling the stock locks in the loss. If you think it is an aberration and it will soon return, then buy! You must know the fundamentals of the company and its industry.

    Best wishes and good luck investing.

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