There are countless resources online that will help you figure out which stocks to invest in and why. One of the things those same resources manage to skip over is also one of the most critical: when to sell a stock.
By knowing when to sell a stock, not only can you get a better understanding of the stocks you hold, but you can also minimise losses and potentially arrive at a benchmark-beating portfolio combination.
Believe it or not, buy-and-hold strategies have a few limits. This article will explain when it’s okay to consider selling a stock.
Then, we’ll give you some pointers about those times you think you want to sell but you shouldn’t.
One minor disclaimer: while shorting a stock is certainly an option, we’ll assume selling stocks in the context of this discussion means closing a position.
The Psychology of Investing
First, let’s give you a brief overview of some of the psychology involved when investing.
If it’s laid out in front of you, the hope is that you’ll remember some of the cues and you’ll understand some of the blind spots.
For individual investors, the most powerful tenet of investing psychology is the fear of regret.
It’s an established theory that has been colloquially called the “fear of missing out” or “FOMO”. It’s what happens when you sell then, shortly after, feel like you should have held (or vice versa).
For that reason, there is a lot of pressure involved in making that final decision to sell.
The best way for you to avoid finding yourself in an uninformed position is, quite simply, to become informed.
Seek help to understand your portfolio, gather data, and make informed decisions.
Remember also that Warren Buffett, the most famous buy-and-hold investor in the world, sells out of positions from time to time.
His reasons are always backed up by data, but there is usually a right time to sell any investment if you understand the right reasons for doing so.
When To Sell A Stock
While there are many reasons and timeframes to sell as stock, we think it’s constructive to highlight 5 main instances, including:
- Rebalancing your investment portfolio
- Sudden price increases
- Changes in your investing purpose
- Sudden bubble (e.g., a “meme stock” craze)
- Deteriorating fundamentals
Let’s now explore each of these instances individually.
1. Rebalancing Your Portfolio
You might not know this, but even passive investing requires a bit of engagement.
There are plenty of guides online that can help you figure out what numbers you should follow, though it’s completely up to you.
If one or two assets in your portfolio rise in value faster than the others, they will take up a larger proportion of your invested money.
This, in turn, increases the risk exposure for those rising assets, and oftentimes, the best thing to do is to rebalance.
RELATED: How to Calculate Portfolio Risk
You do this by selling only enough shares to bring the percentages back to where you had them. Then distribute the profits among the other assets in the portfolio.
This scenario assumes you don’t want to change anything about how you’ve set up your portfolio.
Selling to rebalance your portfolio is encouraged, especially for long-term investing.
2. Sudden Price Rises
Sometimes, the price of a stock will shoot up without warning. But there is usually a reason that you find out after the fact.
Sudden and dramatic price changes tend to happen when many people are wrong all at once.
Falling prices tend to be the most dramatic, but price spiking up can be the result of:
- an acquisition announcement (for the target company),
- a new breakthrough technology, or
- a major contract getting signed, for example.
If you were in the stock before an acquisition is announced, the stock price of the acquired company will usually rise.
It will then typically be rolled into the acquiring company after the merger, so it might be a good time to sell those shares if you want to take in immediate profits.
In the long run, the empirical evidence on M&As tends to show that the acquiring company’s price will likely fall soon after the announcement.
But this doesn’t necessarily mean you should sell immediately.
While ‘synergies’ from M&As tend to be somewhat rare, it’s worth focusing on the business’s overall long term fundamentals.
If those are in good stead, it’s likely that your investments in them will be in good stead, too.
3. Your “Why” Changed
One of the most critical things you need before you even buy an asset is a thesis about what you believe the stock will bring to your portfolio.
Picking a stock is, after all, a lot like hiring an employee – you’re investing in the stock, but something has to be gained from the relationship on your end.
That being said, if your original reason for investing in that stock changed, it may be ok to sell the stock.
Let’s say you bought shares in an oil company when oil prices were low expecting capital appreciation (i.e., you believed the stock price would rise).
Well, oil prices have risen, and oil company stocks have performed well.
However, if you now believe that the oil prices are set to stabilise or even fall, then your thesis of capital appreciation no longer holds. It may be time to consider selling those positions.
Always back up your decisions by seeking out and analysing data – selling based on “hunches” or news reports usually won’t lead to the right decisions.
If you want to explore how you can leverage the power of data to drive your investment decisions, take a look at our investing courses.
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4. Your Stock Is Picked Up By A “Meme Stock” Craze
If you find that the stock you own has become the next meme stock, it is highly recommended to sell.
While the initial spike in price might be a rush, there’s no telling what comes next.
Meme stock crazes tend to be driven more by investor sentiment vis-a-vis any rational justification.
Indeed, this sort of investor sentiment even helps explain why equities are volatile.
5. Fundamentals Are Crumbling
It’s a good idea to keep tabs on the fundamentals of the companies you invest in.
Tracking the data is not as complicated as you might think and seeing trends can help you make objective investing decisions.
If you find that fundamentals are crumbling in the company you’ve invested in, it may be a good time to consider selling.
This may become a bit more obvious if a company you’ve invested in starts cutting its dividends.
When that happens, the company management is in a position where capital preservation has taken over shareholder sentiment and it is usually a bad signal to the market.
Investors tend to get quite “bearish” on stocks that reduce dividend payments.
RELATED: What Does Bullish and Bearish Mean
When Not To Sell A Stock
Let’s now think about the other side of the coin – when not to sell a stock.
1. Short-Term Fluctuations
Stock prices go up and down every day. Sometimes, huge swings in price hit the broad market and may give you reason to panic.
When the markets are panicking, it is imperative that you don’t respond by selling your positions.
The fluctuations you see each day are generally short-lived, though it’s difficult to know if “short-lived” means days or years.
While it’s scary to hold losing positions, have faith in the system and avoid selling based on fear.
2. Technical Analysis Strategies
If the 50 EMA crosses below the 200 EMA, you should probably just keep holding onto your shares.
Technical analysis strategies have proven time and again to not work for the vast majority of investors.
Sure, there are outliers, but most people should avoid them.
Many investors already have some of that knowledge that they learned early in their investing journey.
Remember the reasons you left that behind for real, data-driven investing strategies.
There are some strategies employed by high-net-worth individuals that allow for some tax savings to be realised by selling shares in losing positions.
Realised losses can offset some taxes, but this strategy – also called “tax-loss harvesting” – is not something you should try on your own.
Invest for the long term rather than trying to reduce your taxes.
Remember that taxes help sustain an economy. As long as corruption isn’t a significant issue, you’re almost always better off paying taxes.
What’s Next – When To Sell A Stock
Selling a stock doesn’t mean selling that stock and never going back to it.
It’s important to remember that you can always get back into a position after you’ve had some time to regroup.
Stocks rise and fall in price, so opportunities are presented to you every single day whether you see them or not.
While there are several good reasons to sell a stock, remember that selling a stock out of fear is a sure way to accumulate losing positions.
Never hesitate to reach out to learn more about the difference between objective and subjective decision making as it relates to your investments.
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