Success in the stock market is as much about limiting losses as it is about riding winning stocks. A rule-based and disciplined selling strategy can help you avoid heavy losses and preserve your portfolio value. This lesson explains how to sell when a stock does not perform as per your expectations.

Nobody's right all the time in the market, not even veteran market professionals. But as the famous investor Bernard Baruch once said, "Even being right three or four times out of 10 should yield a person a fortune if they have the sense to cut losses quickly."

If your stock selection doesn't work out and you're faced with a loss, sell to limit your losses; act quickly.

Being a successful investor is just as much about limiting losses as it is about riding a winning stock. Downturns are a part of life in the market, and you must act decisively to protect yourself from excessive losses. If your stock selection doesn't work out and you're faced with a loss, don't let your pride stop you from admitting you've made a mistake and acting quickly. Cut your losses early and move on. You must make rational decisions instead of trying to rationalize your way out of a costly mistake.

The first rule is sell any stock that falls 8% below your purchase price. Why 8%? The first rule is - sell any stock that falls 8% below your purchase price. Why 8%? Because research confirms that stocks with all the right fundamental and technical factors and bought at the proper buy point rarely will fall by 8%. If they do, there's something wrong with them.

You may think a stock is due to rebound. But the market could send the stock to lower depths regardless of your views or what analysts and commentators say on TV. No excuses, no alibis. You may want to sell even before an 8% loss if you see other signs of weakness in a stock.

This rule emphasizes the importance of buying at the right time. If you don't and you buy a stock that is overextended (that's reaching the end of its climb), chances are it will hit the 8% sell level as it goes through a normal pullback. Make no exceptions to the rule. The best stocks will always give you other opportunities to buy. Here's another way to look at it: Once a stock falls 8% below your cost, does it still look attractive? Is it still among the best stocks? Probably not. There's no guarantee that it will go back up, and you need to protect yourself.

The bigger the fall, the harder it is to recover. Say you bought a stock at Rs.100 a share. It falls 20%, to $80. To get back to Rs.100, the stock has to make a 25% gain. Another example: The stock plummets 50%, to Rs.50 a share. It would take a 100% jump to get it back to Rs.100 - and how often do you buy a stock that doubles? And if it does, how many weeks, months or even years does it take to get there? Wouldn't you rather cut your loss early, and free up money to purchase another stock with better chances of doubling?

Of course, it could happen that you sell a stock that falls 8%, and then watch it go up afterward. But you have to think of the 8% sell rule as your insurance policy against catastrophic losses. The rule will in effect limit any losses on your portfolio to no worse than 8%.

Nevertheless, if you've bought a fundamentally sound stock at the right point, (explained in the stock buying lessons) it will rarely plunge 8% immediately. Buying exactly right will solve half your selling questions.

As you can see, even if you had made these seven trades over a period of time - and taken losses on five of them - you would still come out ahead by Rs.1,500. That's because the two stocks that worked out resulted in a combined profit of Rs.3,500. And the five losses - all capped at 8% - added up to Rs.2,000.

You see the point? It would take several 8% losses to wipe out the profit from just one or two good stocks.

The 8% sell rule, however, applies only to drops below your purchase price and does not apply to situations where you've already made gains on a stock.

About 40% of stocks pull back close to their buy point for one or two days. This is not the time to panic and sell, especially if the stock was purchased as it came out of a sound basing area at the right buy point. (For more on this, check lessons on charts ) As long as the price doesn't drop 8% below the point at which you bought, you should, in most cases, hang on through the first pullback.

Watch how the stock performs relative to the general market and its industry group peers. Often, a stock pulls back close to the buy point for one or two days because the general market has temporarily pulled back. This is normal. On the other hand, if the market has been rallying over several days and your stock hasn't come to life, then this might be a warning sign, even if the stock hasn't dropped 8% below your purchase price.

“Sell if the stock falls to 8% below my purchase price,” Anand tells his stock broker – example of a stop loss order.

Some investors like to use stop-loss orders, which are instructions to brokers to sell a stock at a predetermined price. This might be useful for those who can't watch their stocks closely or for those of us who may be less decisive.

Tax considerations and brokerage charges should not be given importance in your sell decisions. You shouldn't always hold a stock for more than a year just to avoid paying tax on the profit. And with lower brokerage charges today, they should not be the most important factor. Your main goal should be to make and retain profits.

You may notice that your portfolio includes some stocks that are already 8% below your purchase price — or worse. Should you sell them? Probably yes because as the stock goes lower, it becomes even more difficult to sell. It is easier to sell a stock which is down 8% to a stock which is down 30%. You feel that the stock cannot go lower but feeling has no significance in the stock market. There is no guarantee it will rebound and the chances are it could go even lower. The greater the loss, the greater the chance of it developing into a really serious loss.

• The first sell rule is to get rid of any stock that falls 8% below your purchase price.
• It's critical to follow this loss-cutting rule regardless of how highly you value a stock. Personal opinions get in the way of smart selling decisions.
• The larger the loss, the higher the recovery you need to get back to the break-even level. (A 50% loss requires a 100% gain to break even.)
• Strong stocks sometimes initially retreat close to their buy point (as determined by the stock's chart pattern). This doesn't necessarily mean you have to sell, unless the stock goes 8% below the purchase price.
• Avoid making sell decisions based on tax concerns or commission rates.