This Mistake Could Cost You a Fortune

Man, was that ever a brutal year ...

Granted, it's not like I made a big bet on DryShips (Nasdaq: DRYS  ) at the beginning of last year -- right before it dropped more than 75% (although I know people who did). And I certainly didn’t listen to any of the doom-and-gloom pundits who suggested you short “zombie banks” like JPMorgan Chase (NYSE: JPM  ) and Morgan Stanley (NYSE: MS  ) just before their epic rebounds.

But I did move back to Big 12 country just in time to see my beloved Oklahoma Sooners lose game after game after game -- not to mention lose their Heisman-winning quarterback, Sam Bradford, to a season-ending shoulder injury mere minutes into their opener.

You see, my grandfather played football for Oklahoma, and I've been rooting for them since I was old enough to walk, so 2009 was a pretty painful year for me. But don't worry, I'll always be a Sooners fan -- no matter how bad things get. In sports, that's a virtue.

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

Stock

10-Year Return

Merck (NYSE: MRK  )

(22%)

Corning (NYSE: GLW  )

(46%)

Home Depot (NYSE: HD  )

(47%)

Sun Microsystems (Nasdaq: JAVA  )

(94%)

Data provided by Yahoo! Finance.

Or ask my fellow Fools Rich Greifner or Adam 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 -- and time after time, investors ride stocks right into the ground because they're emotionally attached to a company's story, products, or management.

I, for one, am sitting on a major loss in Clearwire. And if we're being honest, the only reason I bought shares in the first place was because I liked that it was backed by Google, Comcast, and a handful of other tech heavyweights.

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 might seem cruel and unusual, but is it good investment advice?

To find out, I dug through David and Tom Gardner's Motley Fool Stock Advisor picks. You see, they often re-recommend a stock even after a big run-up -- or a sharp fall.

As it turns out, I found three examples when breaking IBD's rule actually paid off big-time:

Stock Advisor Pick

Decline After Recommendation

Gain After Re-Recommendation

Netflix

23%

294%

Quality Systems

14%

1,189%

Dolby Labs

10%

163%

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."

And he had well-thought-out reasons for continuing to own 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 313% since then.

So when do you sell?
Many investors have hard-and-fast numerical rules. 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
Investors may never agree on when or why to sell a stock. But it is 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.

For what it's worth, David and Tom Gardner rarely sell, and it works for them. In fact, Tom's average Stock Advisor pick is performing more than 35 percentage points better than a like amount invested in the S&P 500. Meanwhile, David's are performing 66 points better on average.

If you'd like to see which stocks David and Tom are recommending investors buy (and sell) right now -- including their two top picks for new money -- you can take a free 30-day trial of Stock Advisor.

In addition to all of their 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.

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

Austin Edwards owns shares of Google and Clearwire. Dolby, Netflix, and Quality Systems are Stock Advisor picks. Google is a Rule Breakers pick. Home Depot is an Inside Value pick. Though generally not a sports fan, The Fool's disclosure policy enjoyed watching Oklahoma upset Toby Gerhart and the Stanford Cardinal in the Sun Bowl. Boomer Sooner!


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