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Sit Tight: Tips For Dealing With A Pullback After The Breakout

Cutting your losses short is one big key to successful investing, but it's not that easy to figure out whether you're selling prudently or just getting shaken out.

IBD tries to help in this regard with some guidelines on pullbacks after a breakout.

One guideline is the 7%-8% sell rule. When a stock breaks out in proper fashion from a consolidation, you should buy as close as possible to the ideal buy point, but then — according to this rule — sell if the stock ends up falling 7% or 8% below your purchase price.

IBD's research has found that most big winners won't drop back below their buy points after a breakout. Most is not all, however. About 40% will undercut their buy points, according to this research. Still, they generally won't trip the 7% or 8% sell rule, so you should sell if your stock does so.

Another useful guideline for pullbacks after a breakout has to do with the 50-day moving average (or on a weekly chart, the 10-week moving average). This guideline says that a first or second pullback to the 50-day or 10-week line is fine, but once you see the third or fourth pullback, it's smart to turn a bit more cautious about that stock.

Keep in mind that retreats from a breakout don't have to follow any particular schedule. You might see them happen the very next day, or it might be several weeks or a couple of months later.

Check out CommVault Systems'(CVLT) action last year, if you want to learn about pullbacks after a breakout.

In September, the stock broke out beyond a buy point at 53.90 from a cup-with-handle base. Within a few sessions, it showed a gain of 10%, but then it moved sideways for about a month. (1) Then, just ahead of a quarterly earnings report, the software maker undercut its 53.90 buy point.(2) However, the stock dropped only 2% below that level, so you wouldn't have sold based on the 7% or 8% sell rule.

The drop in late October also represented CommVault's first test of support near its 10-week line, rather than a later-stage test. So that also shouldn't have caused alarm.

Investors who held on during this first pullback were rewarded, as CommVault soared on big earnings and built on that gain.