As difficult as it can be for some people to decide to buy a stock, it can be just as difficult ─ if not more so ─ to decide when to sell it. In truth, there’s no single rule for determining when to sell a stock. But one thing can help: knowing why you came to own the stock in the first place. If you set a specific goal, it’s far easier to let a stock go once it has reached that goal.
To provide a focus here, we’re going to consider two kinds of scenarios. The first is when you’ve made money on the stock. The second is when you haven’t, either because the stock price has been flat, or it’s lower than when you bought it.
When You Have a Profit
Short of needing money, is there any reason to sell a stock that has made a profit? The very idea seems to fly in the face of the fact that failing to let winners run is one of the most common mistakes individual most common mistakes individual investors make. Nonetheless, there are several reasons for selling some or all of a position in a profitable stock:
- The company has fundamentally changed character and is unlikely to continue to grow in value. This is often very difficult for casual investors to assess until it’s too late, but it’s not at all uncommon. Think of some leading examples from the last 20 years or so: AT&T, Enron, General Motors, and Lucent, just to name a few.There are at least two different ways to detect that kind of change. One is by tracking the company’s fundamentals and changes in long-terms trends. Are the company’s highest levels of sales, profitability, and market share more than three to five years in the past? Has it been overtaken by competitors that once were far behind? Has it cut its dividends more than once, severely reduced its research and development spending, taken on unusually high levels of debt, or had its credit rating reduced several times in the past few years?
Another way to detect change at a company is to study the chart of its price changes over time. Adjusted for splits, was the stock’s highest price many years in the past? Has the long-term trend line shifted to a flatter or negative slope? Is the stock having trouble piercing through resistance points that are far below its highest levels? These, too, can be signals that there are better places for your money.
- You need to rebalance your portfolio. One of the tools professional money managers use for raising long-term portfolio returns and reducing risk is to rebalance. That means selling some shares of positions that have grown out of proportion to your asset allocation strategy and using the profits to buy more shares of issues that have gone sown in price. This has the effect of locking in some of your gains while increasing your potential return by leveraging more shares of an investment that later recovers in price.
- You’ve identified a better opportunity. This is closely related to the first reason. The difference here is that the stock you own hasn’t changed its intrinsic character, but another stock with similar or better risk characteristics offers better returns, either through growth or dividends.
When You Have Losses
This is the easier of the two scenarios, because it can come sown to answering one simple question: if you didn’t already own it, would you buy it today? If not, sell. If so, keep it. If you would buy it, it’s because the fundamentals haven’t changed. But if you’re not skilled at this assessment, you could be making a mistake.
The danger is that you may not recognize the need to sell. Sometimes, stocks go down for reasons that have nothing to do with the underlying value of the company. It could be because of a bad economy or bad news to which the market overreacts. These could actually mark opportunities to buy more shares at a cheaper price.
On the other hand, there can be very good reasons the stock has been going down and will continue to do so. If this is the case, the smart move is to cut your losses, no matter why you own the stock. You may want to prove to yourself that you didn’t make a mistake buying it, or you may have inherited it from a dear relative who held it for decades. Neither of those will compensate for more losses.
The bottom line is unless you have the skills of a highly trained and experienced professional, it’s best if you don’t make decisions to sell a stock on your own. Please call if you’d like to discuss this in more detail.
Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.