How Do You Know When To Sell A Stock
You have owned one of those amazing technology stocks over the last decade and you are beginning to wonder…is it time for me get rid of this stock? Or, should you hold on to it like your parents or grandparents held on to their blue chip stocks until the day they passed it on to you? Maybe you just bought one of those blazing marijuana stocks and made a nifty profit and are thinking you should sell it because it may just be a fad. Just like sitting down at the Blackjack table in Las Vegas, we all know how to pull up a seat at the bar, we know how to place some bets, but if we start winning most of us don't have a strategy about when is the right time to cash in your chips.
It's interesting to see the different philosophies that reside on the internet today. The Motley Fool, one of the largest investment websites on the planet, says there are six reasons that should impact when you sell a stock.
- If you are losing sleep over how your cash is invested.
- You need the money in the next three years.
- The original reason you bought the stock no longer holds true.
- There are better places for your money.
- Selling could help you reduce taxes.
- You need to rebalance your portfolio.
Investors.com comes up with three ideas about selling stocks:
Limit Your Losses to 7%-8%: Even the best stocks will sometimes break out, and then drop to slightly below their ideal buy point. If your stock declines more than 8% it usually means something is wrong with your chosen entry point, the company, its industry, the general market, or all the above.
When to Take Profits: One of the greatest feelings is seeing your stock's price go up. But how long should you let it ride before taking cash off the table? During a healthy market uptrend it's smart to take most profits at 20%-25%.
The 8 Week Hold Rule: If a stock has the power to jump over 20% very quickly out of a proper base, it could have what it takes to become a huge market winner. The 8-week hold rule helps you identify such stocks. When your stock reaches a 20% gain in less than three weeks, hold for at least eight weeks.
Investopedia, another large and popular website introduces a concept called The Casino Trade- Why Selling Is So Hard:
The reason why many have trouble selling is rooted in an innate human tendency to be greedy. For example, an investor purchases shares of stock at $25 a share, and tells herself that if the stock hits $30, she will sell. What happens next is all too common. The stock hits $30 and the investor decides to hold out for a couple of more points. Surely, the stock reaches $32 and greed continues to overcome rationality. She holds out for more.
Suddenly, the stock price takes a turn downward and is back at $29. The investor then tells herself that once the stock hits $30 again, she will sell it all. Unfortunately, this never happens, and the stock price continues to drift lower. Succumbing to her emotions and frustrations, the investors sells at $23, below her initial buy price.
As greed and emotion overcame rational judgment in this scenario, sound investment principles were replaced by casino-like tendencies. The initial result was a loss. And while the investment loss was $2 a share, the true loss was $9 because the investor had the opportunity to sell at $32 but refused. Sometimes these types of paper losses are better ignored than agonized over, but it all comes down to the reason an investor chooses for selling or not selling. A sound selling decision that leaves some profit on the table may look more like a poor selling decision, but the process by which an investor makes their decision is critical.
Knowing when to sell is of paramount importance. From the example above, proper selling reduces the likelihood of suffering two ultimate consequences. In the first instance, proper selling helps ensure the preservation of gains. In the second instance, proper selling reduces the likelihood of incurring major losses.
To remove human nature from the equation in the future, consider using a limit order, which will automatically lock in your target price and sell once it reaches that price (excluding gap-down situations). This will prevent you from having to log into your trading account, or even looking at the stock price. You will be notified when the stock sold, and barring a gap-down situation, you will be happy with the gain.
There so many philosophies on how and when to exit a stock. Some of them range from very technical philosophies about Price to Earnings ratios to looking at the trends of what people are buying when it comes to something such as consumer products. Think about this. In the early 2000's you had two major handset companies that nobody thought could fail which included Motorola (who didn't want a Star Trek flip phone) and Blackberry (what corporation couldn't live without their Crackberry?). Most people are quick to forget that Blackberry was more than $120 stock just over a decade ago and today trades for only $7.52 (as of 1/11/2019). Were there people in the mid 2000's that thought Blackberry was going to take over the planet? You bet there were and now they have lost 90% of their value since the height of the stock. Do you think there are people that are certain that the big smartphone companies cannot fail today? You bet there are- plenty of them. Will they be right? Will they be wrong? Should they hold on to those stocks forever because you can never again say that any company won't potentially go out of business?
After reading all the articles, here are four rules that I think you might want to consider when on when to sell a stock:
- Decide what your target is for profit or loss: Before you buy the stock, just ask yourself how much are you willing to lose and what level of profit do you want to make? By doing this and putting discipline to your strategy, you'll be less emotional about the bigger winners and bigger losers. Hindsight is always 20/20.
- Decide the main reason you own the stock: If you buy a stock and you own it because you love the management team, you love the products, you love the industry, or your love the business model, then you should be selling by discipline for the main reason. If you loved a certain kind of toothpaste, technology, or hotel chain and you no longer love it, why would you still own the stock?
- Never let the tax tail wag the dog: There are so many people that become stubborn to sell a stock because they don't want to pay capital gain tax. Is a 20% tax on the stock better than having a 50% loss? I have seen so many people hold on to stock they own simply over taxes.
- There are no Silver Bullets: So many people still to this day take advice at the bar, at the water cooler, or worst of all at the chat rooms on the internet. Of course, everyone wants the next Amazon, the next Netflix, the next greatest place they can turn $1,000 into $1,000,000. Finding those diamonds in the rough are just as challenging as winning the lottery. If you have no clue whatsoever on why you own a stock beyond that someone's buddy's buddy told you about it, then it's probably a good sign to dump it.
There is no bulletproof strategy on the right time to sell, but the key is having a disciplined policy on why you buy, how long you hold, and when you sell. If you can be disciplined over the long term and that is the key to your strategy, you can have a better chance of creating more wealth down the road.