The Golden Rule of Investing

      If there is a golden rule of investing, it should be the discipline to cut your losses when a stock drops 7-10%. The usual protest to this idea is "what if the stock goes right back up, as I know it's going to do? I've lost 10% of my money for no good reason."

     Let's take a logical look at this argument. If a company's stock price drops 8%, it can then do three things. It can go right back up (but then why did it take a big drop in the first place? Hmmm), stay right where it is, or most likely drop even further. Sorry, but dropping to even a lower price is what’s most likely to happen.

     For example, you buy a stock at $25.00, it drops to $23 where you sell and take a $2 loss. Over several weeks or months, you watch it drop down and hold at a "support level" of $17 to $19. The price begins to move up so you buy back in at $20. A month later it is back to $25.00.

     If you had simply held on to the shares, you are now back to a break-even point. But by getting out early then buying back in as it began to come back, you made $5, minus the $2 loss, for a gain of $3 per share. Not only that, you protected your investment from greater loses if the stock continued falling and not regaining its old price level. This happens all the time!

       I know so many investors that have stocks in their portfolios of good companies, and the stock seemed fairly priced and had great potential when they purchased it. They bought IBM at $125, then watched it drop to $65.00. They bought AT&T at $60, then watched it drop to $9.00.  They bought Enron at $70.00, then watched it drop to $0.00.