7% Sell Rule: O'Neil Stop-Loss Explained

The 7% sell rule na William O'Neil instruction to sell any stock wey fall 7% to 8% below the price wey you pay for am, with no exception and no waiting for rebound. Na loss cap, no be forecast: the work na to keep every mistake small enough so ordinary winner fit pay for am.

Wetin be the 7% sell rule?

O'Neil start Investor's Business Daily (IBD) and explain the rule for How to Make Money in Stocks. If stock wey you own trade 7% or 8% below your purchase price, you sell am at market for that session, no matter wetin you think about the company. IBD describe 7% to 8% as the outer limit, no be target: after poor entry or for weak market, you cut the loss sooner.

Four details dey easy to miss.

1. The reference na your purchase price, never the stock high; holding wey gain 20% then give back 10% never touch the rule.
2. The trigger na the price, never the story. You make the decision before time and execute am when you least want act.
3. E pair with the CAN SLIM entry rule: O'Neil claim say stock wey person buy at proper chart breakout hardly drop 8% below the buy point.
4. No averaging down. Adding below your cost go defeat the cap.

Why 7%? The recovery arithmetic behind the rule

Losses and gains no dey symmetric, and the difference dey grow as the loss increase. After 7% loss, $100 become $93. To return to $100, you need $7 gain on $93 base, wey be 7.5%. The general method na to divide the loss by wetin remain. The hurdle dey climb faster than the loss.

• 7% loss need 7.5% gain to return to even.
• 10% loss need 11.1%.
• 20% loss need 25%.
• One-third loss need 50%.
• 50% loss need 100%.
• 75% loss need 300%.

The panel below calculate the hurdle for each of those loss sizes.

SELECT
    concat(toString(round(loss_pct, 1)), '%') AS loss,
    round(loss_pct, 1) AS loss_pct,
    round(100 * loss_pct / (100 - loss_pct), 1) AS gain_needed_pct
FROM
(
    SELECT arrayJoin([7, 10, 20, 100 / 3, 50, 75]) AS loss_pct
)
ORDER BY loss_pct

The cap keep every mistake for the flat part of that curve. O'Neil explain say when losses stay at 8% and gains reach 25%, trader fit get two wrong trades and one right trade and still come out ahead: two 8% losses cost 16 units, one 25% gain return 25, leaving net 9 before costs. Na the whole case for the rule.

How traders dey use the 7% rule with stop order?

Most followers enforce the rule with resting order wey dem enter immediately the purchase fill. Two order types fit do the work.

A stop order (stop-loss) dey wait at trigger price. When the stock trade at or through am, the order become market order and fill at the next available price. Buy at $100, stop at $93: print at $93 go trigger the order, and for liquid stock the fill fit land within few cents of $93.

A stop-limit order dey wait at the same trigger but convert to limit order at the second price wey you set. Stop at $93, limit at $92: the order trigger at $93 and fill at $92 or better, or e no fill at all. E protect against poor fill but give up the certainty of getting out. Full comparison dey for stop order versus stop-limit order.

Since 2016, NYSE itself no longer accept stop orders; your broker hold the instruction and send the market order when the trigger print, usually only during regular session. The rule no apply to option contracts, where 7% stock move fit routinely become 30% to 50% move for the contract; stop orders on options explain the difference.

Stop fit fill far below 7%?

Yes. Stop only work while market dey open and stock dey trade through your level. Earnings release after close or downgrade before open fit make stock gap overnight: stock wey close at $98 fit open at $84 without ever trading at $93. Your stop go trigger for the first print near $84 and fill there, creating 16% loss on position wey you cap at 7%. The mechanics of that gap dey for why stocks gap overnight.

Stop-limit no go save you here. With limit at $92 and open at $84, the order go remain unfilled and you still hold the stock. The rule as IBD state am no pause after gap: the loss don pass plan, and the instruction na to take am instead of waiting for the gap to close. Position size, no be order type, na wetin limit gap risk.

The 7% rule concern ETFs, returns, or withdrawals?

The phrase dey mix with two unrelated ideas for search. The first na the commonly cited long-run average real return of US stocks, roughly 7% per year after inflation over very long periods. Na historical average, no be rule. The second na the "7% withdrawal rule" for retirement planning, an aggressive cousin of the 4% rule. E talk about how much portfolio to withdraw each year and nothing about selling losers. Neither concern O'Neil.

The live question for ETF holders na whether the sell rule belong on index fund. O'Neil write am for individual growth stocks wey dem buy at breakout. Broad index fund go fall 7% below some purchase price during every correction, meaning decline of 10% or more. Whether hard cap belong on holding wey person plan to keep for decades depend on the purpose of the holding, and the rule as written no address am. The 3-5-7 rule in options and the 8-4-3 rule for mutual funds too no relate.

Wetin be the criticism of fixed 7% stop?

The main objection na say fixed percentage no consider how much the stock dey move on normal day. Stock wey dey swing 4% or 5% from one close to the next fit trade 7% below almost any entry because of ordinary noise alone. For that stock, the stop dey closer to coin flip on the daily range than verdict on the thesis. The same 7% for stock wey move 1% per day na rare event.

Whipsaw na the cost: series of small losses and re-entries, with each one paying the spread. O'Neil answer say buying back stock wey break out again dey allowed; how long a losing streak is normal put figures on how long such runs fit last.

Volatility-scaled alternatives address the objection directly. None better in every situation; each one trade whipsaw against give-back differently.

• ATR stops set the distance as multiple of average true range, the stock typical daily range over recent weeks. So the stop widen for volatile names and tighten for quiet ones.
• Fixed-dollar risk with variable stop start from the money wey you ready to lose, maybe 1% of $50,000 account, or $500. 7% stop then allow $7,143 position; 15% stop on wilder name allow $3,333. Same loss if you wrong, different position size.

The panel below run that sizing at three stop distances.

SELECT
    concat(toString(stop_pct), '% stop') AS stop,
    round(500 / (stop_pct / 100)) AS position_size_usd
FROM
(
    SELECT arrayJoin([7, 10, 15]) AS stop_pct
)
ORDER BY stop_pct

The thing both share with O'Neil rule na the part wey matter: you decide the exit before the entry and enter am as order, instead of holding am as intention.

FAQ

Wetin be the 7% sell rule for stocks?

Na William O'Neil rule, taught through Investor's Business Daily: sell any stock wey fall 7% to 8% below the price wey you pay, with no exception. You measure am from your purchase price, never the stock high.

Why 7% loss need 7.5% gain to recover?

After 7% loss, $100 become $93. To return to $100, you need $7 on $93 base, wey be 7.5%. The recovery gain na the loss divided by wetin remain, so the hurdle dey grow faster than the loss; 50% loss need 100% gain.

The 7% rule apply to ETFs and index funds?

O'Neil write am for individual stocks wey dem buy at chart breakout and e no address index funds. Broad index fund go drop 7% below some purchase price during every correction, so applying the cap to long-term fund holding na judgment wey the rule itself no make.

The 7% rule be the same as 7% return or 7% withdrawal rule?

No. The 7% average annual real return na long-run historical figure for US stocks, while the 7% withdrawal rule na retirement drawdown rate. Both no relate to O'Neil rule for selling losing stock.

Percentage stop easy to state but harder to size. If you want know how often stock close 7% below prior close, or how large overnight gaps don reach, ask for plain English on the Strasmore terminal.