Knowing when to sell a stock or any other security is one of the most underappreciated skills in the financial markets. Investors mostly focus on when to buy, as is always the case with most financial advice.
Whatever is bought must always be sold, as this is the only way, one would be able to generate profits from the markets. Purchasing a security at the right price is essential. However, the gain only happens when exiting the market at the right price.
Selling a stock too soon when it is generating profits is one of the biggest mistakes that most people make. Also, there are those who wait in the hope that a loss-generating position will turn around and start generating profits.
Over the years, studies have shown that investors are likely to sell a stock that is generating profits and hang on to a position that is accruing losses.
Finding a balance on when to keep a position running or when to shut down, a loss-generating position should be the ultimate goal of any investor in the equity markets. However, indecisiveness is one of the biggest hurdles that stand in the way of most people succeeding in the market regarding generating profits.
A trader may buy shares of a given stock at say $50 with the plan of selling them when the price strikes the $55 mark. What would happen most of the time is that the share price would rise to the $55 a share level, but the trader refrains from exiting the position on the belief the price will continue rising.
In some instances, the price might rise past the $55 mark, and without a take profit order in place, a trader would be able to accrue more profits than initially anticipated. However, the test comes when the price starts dropping. As is the case with human nature one would refrain from closing down the position even on the price dropping below the entry level.
Indecisiveness on when to exit a position could result in one accruing more losses on a share price dropping significantly. It is for this reason that investors especially novice traders always find themselves in a dilemma on when to sell a stock.
What to Consider Before Selling a Stock
Just as is the case with buying a stock, selling a stock requires much planning as possible. Selling a stock based on price movements will never cut it, given the human emotions that are always in play.
Predicting the exact moment when a stock will reach higher highs to exit a position is not an easy feat. For this reason, it is impossible to time a sale perfectly. However, there are developments that act as early signals for triggering a sell.
Any trader should always establish guidelines upfront that would guide him or her when to sell a stock before opening a position. Below are some of the things that one should consider before selling a stock.
Read: Guide to Value Investing
Underlying fundamentals that dictate share price movements are continuously changing. The directions in which a share price will move will most of the time come down to how a company responds to changing economic cycles that affect fundamentals. Traders enter long and short positions while taking into consideration underlying developments.
Many at times a share price will continue powering high on investors taking note of improving fundamentals, which could be in the form of the company unveiling new products or gaining market share. In this case, holding on and avoiding the temptation of selling the stock would be the right call.
However, in the event of underlying fundamentals taking a hit, a trader should be ready to trigger a sell order. A decline in sales, soaring debt levels or cash flow showing signs of stress, are some of the early warning signs of declining fundamentals.
A strong competitor entering a market to the extent of stealing market share is more than enough reason to sell a stock. A company whose accounting practices have come under question or a company whose net loss appears to be widening should worry any trader and provide valid reasons to sell a stock.
Sudden management changes or delays on the unveiling of new products should also ring alarm bells of the need to consider selling a stock.
It is common practice for people to invest in stocks only to realize much later, they made a mistake. Analytical mistakes arise from failing to discover, in advance errors, which have the potential to affect a company’s ability to generate long-term value.
The key strategy of enjoying a successful investment career is basing all investments on accurate and immediate data. If the initial analysis were flawed, then it would be wise to sell a stock even if it has turned positive. It is because share price would most of the time correct, to reflect a company’s actual value.
However not all analytical mistakes should form the basis of selling stock, For instance, a company might fail to meet short term forecasts resulting in a drop in share price. Holding on to a position, in this case, would be the right call if the soundness of the business is still intact, pointing to long-term growth.
A Better Place to Invest Capital
Financial markets are constantly fluctuating in response to new policies, developments as well as regulations. With the fluctuations, so do new opportunities emerge some of which tend to be much better concerning value generation compared to others.
A trader can consider selling stock as a way of freeing up some cash for investing in another lucrative opportunity. The opportunity could be in the form of another stock with better long-term prospects.
In times of low-interest rates, equities tend to be some of the best investments given the influx of capital into the market. However, central banks hiking interest rates make government treasuries such as bonds highly lucrative given their potential yields on high-interest rates. In this case, one can sell stock to free additional capital to invest in the bonds market.
The Pursuit of a Tax Break
One of the best times to sell a stock is when one is guaranteed lower tax rates while filling for tax returns. Selling stock in a taxable brokerage account can lead to a higher tax charge if the stock has increased in value. It is thus necessary to get the timing right when exiting a position in the market.
Any stock held for more than one year in the U.S is eligible for lower long-term capital gains when it comes to tax rates. In this case, one should avoid the temptation of selling stock, held for less than one year, as it will be subject to a higher short-term capital gain rate.
Tax loss harvesting is another provision that allows people to enjoy the benefits of lower tax rates. The provision applies to stock positions that have lost money. Upon selling, one is always guaranteed of a lower tax rate while filling for tax returns. In this case, any amount lost in an investment can be used to offset any taxable investment gains, resulting in a reduction in the amount one has to pay as taxes
Target Price Consideration
Setting a target price for profit and loss taking is a sure way of avoiding unnecessary stress in the stock markets. Professional traders set the floor on a stock price, upon which they exit a position on the share price striking the level.
When setting a target price one would exit the market on the price falling below a certain level, which could lead to a significant loss. Conversely, one can set an upper limit in case of a buy position, to exit the market on accruing a substantial amount of profit.
Setting a target price allows one to sell a stock at specific levels be it on generating a profit or a loss, therefore, freeing some capital to invest in another opportunity.
Company Trims or Eliminates Dividends Altogether
Dividend payments are associated with companies that are doing well when it comes to cash flow generation. Such companies tend to elicit strong investor interest that most of the time fuel a rally in share prices.
However, whenever a company starts cutting or eliminating dividends, then it is a sure sign of something amiss as it signals a potential slowdown in business as well as profit margins. It is one of the earliest signs of things about to get out of hand and one of the alarm bells to consider for selling stock.
Growth stocks are some of the best to invest in, given their ability to generate long-term value. Whenever such stocks stop growing and begin to slow, then it would be wise to offload them. The markets never take it kindly whenever a growth stock starts to falter on margins which most of the time results in a sell-off.
Hype in the markets is at times a good thing especially if one has already opened a position and enjoying the ride. However being a double-edged sword, media hype on a stock can spell trouble if one is not cautious enough.
Whenever a stock becomes the focus of media attention, then having an exit plan in place is necessary. The thing with media hype is that it tends to attract inexperienced investors, who shore up the share price to unjustified levels. Such rallies come in total disregard of underlying fundamentals ending in unexpected crashes in the long run.
Professional traders set sell stop orders that allow them to exit the market before the hype sending shares up cools off. If you have already accrued substantial profits, consider selling part of the stock to take out some profit, before the adverse effects of the hype creep in.
Rebalancing a Stock Portfolio
Portfolio rebalancing is an essential aspect in the equity markets. Portfolio rebalancing involves tweaking the amount of capital exposure one has on a single stock through either trimming shares holdings or buying more. Spreading bets all around is a sure way of generating significant returns on a diversified portfolio.
Most professionals would counsel against having more than 20% exposure on a single stock in the market. Should a stock exposure exceed that threshold, it would be wise to sell some shares of the given company as a way of rebalancing the investment portfolio.
One of the best ways to balance an investment portfolio involves buying more shares of a stock that has fallen behind, compared to its peers and selling shares that have outperformed. Selling shares of a company that has outperformed helps one take in a profit before the market pulls back or turns around.
Selling For Personal Financial Needs
One of the reasons people invest in the stock market is to be able to generate some money to meet various financial needs in the long run. Stocks are just like any other assets, which means in times of financial needs one would be right to sell, to generate cash for financing underlying needs.
It is therefore to sell a stock, be it at a profit or a loss, in case one is cash strapped and in dire need of money to finance, things like college fees or purchase a new home.
When it comes to investments, there will never be a perfect time to sell a stock. Any sell-off would always come down to what one was thinking when they bought the investment. Experts’ advice on selling a stock only when it does not meet the original investment criteria, leading to losses, or upon a stock rising to the desired level and generating the desired profits.
Any stock sell that has the potential to result in profits will always be the right call especially on meeting the initial investment objectives. Besides, whenever a sell results in a loss, accompanied by the conviction that it is the only option for avoiding additional losses, then pulling the trigger would be the right call.