Choosing the shares you would like to buy is the first step of a successful journey on the stock market, but choosing when to sell might be even more sensitive. This article aims to give you the tools you need to carefully consider this decision.
You bought these stocks and they were going up and up. You decided to hold, hold, hold, until one day, the price fell. Wow, it is even below the price at which you bought them. Or there is this other time when you bought a stock for $45 each. A week later, they got up to $50. So you sold them all, only to see that they’re scrapping $100 dollars the following week. You then feel like a failure and wonder why you even started trading in the first place.
If this has ever happened to you, well, this article is for you. If not, this article will ensure you do not fall for this mistake. Not too often, at least.
It is a fact that, often, speculators and investors do not always know when to sell a stock. Either you wait too long and miss the peak, or rush to sell before the right moment, loosing some potential value on the way. How, then, can we determine the right time to sell and close for profits? Some people will advise to sell stock as soon as the market is going down. Although this seems logical, it neglects the fact that the Financial market can sometimes rebound after a loss. Others will tell you to hold on to you winning stocks forever, while others will tell you to sell them following a very strict decision process.
Signs you might need to consider selling
Although there is no way to be 100% certain all the time, there are some indicators you can follow in order to perfect your timing. You will see that it pays to have a stock exit strategy.
Some changes in the dividends
If a company decides to lower, or even to eliminate dividends altogether, this must be seen as a red flag and calls for a thorough examination.
As you may know, dividends are cash given by the company to their investor, as a reward for holding their shares. Taking the decision of suspending them might be an indication that the financials of the company are not doing so well.
Not that dividends are mandatory. The company could also simply decide to invest the yearly dividends into R&D or further investments. However, if you’re an investor counting on dividends for profit, I would suggest you have a closer look.
Lower stock liquidity
Stocks that are doing well are in demand. Everyone wants to be part of the party and fear missing out. Therefore, the trade volume tends to be high as stocks are exchanged around.
However, when a market gets stale and the stock is not being frequently bought and sold, this might be an indication of weaker financial performance. In a worst-case scenario, liquidity could drop so much that you cannot sell for lack of buyers.
Unsatisfactory Company analysis
If you can access the company’s financial statements, there are various data which you can use to determine the financial health and performance. There are many ratios you can calculate such as the dividend yield, the price/earning ratio, the earnings per share and so on. You can also check the liquidity of the company looking at the quick ratio, their debt to equity, current ration, etc.
You must note that financial ratios are sometimes not comparable, especially when looking at companies of very different sizes and industry. Also, they show you a performance over a certain period of time only.
Selling strategies: most common practices
Now that we have outlined the main signs which you should be aware of, let us try to establish some strategies that will help you choose the right time to sell your stocks.
The target price
Some investors choose to set up a specific price. If the stock value goes below this price, they will sell immediately to ensure a certain profit. In the same way, it is also possible to set up an upper limit in order to automate selling at a certain profit. In this case, you believe the stock will not be able to maintain itself at such a high value, and that the smallest bad news will send it back down.
Other investors just aim for a fixed profit. Once the stock reaches a price fixing such a profit, they simply sell and move on to another opportunity. The main advantage of this technique is that it makes sure that you do not succumb to emotionally driven decisions, preventing you from panic selling and helping your revenues over the long run.
The 7-8% rule
This strategy is rather simple: always sell your stock if it falls 7%-8% below what you paid for it. No questions. No exceptions. This is about the surest insurance to not transform a small loss into a very damaging one to your portfolio.
This rule is based on a study based on 130 years of stock trading history which showed that even the best stocks might break out and fall below their ideal price point. However, they generally do not loose more than 8%. If this is the case, data shows that there is something wrong with the stock/company. Small remark: you do not have to wait for your stock to reach 8%. If it falls 3% but you still think something is wrong, cut it. Your number one priority as an intelligent investor is to safeguard your capital.
The 20-25% rule
Same rule, but the other way around: in order to grow your portfolio substantially, your best bet is to cash in most gains between 20% and 25%. As IBD founder William J. O'Neil says, "The secret is to hop off the elevator on one of the floors on the way up and not ride it back down again."
This makes sure you have a fair return and that you get out while everything is going well, one step ahead of the decline. Following this rule with consistency might not make you win the most money on your trades, but it is safer than greedily waiting and to enter the downfall.
Do not sell all your holdings
You do not have to sell all of your Apple stock at once. One good way to mitigate the risk is to sell only a portion of the position so that you can invest the cash elsewhere. On the other side, you still keep a part of your share in the company. This ensures that you are not fully exposed to a decline in the stock price, but that you can also capture another rise.
Beware of the media hype
When a stock gets too much attention, you ought to be very careful with it. Extra media coverage will tend to attract many investors, which will result in a sometimes-unjustified rise in the stock price. This is fine as long as speculators keep buying. But when the price gets too high and the hype shatters, you might be in for a big decline, which you want to avoid at all cost. Therefore, beware of media attention. You need to weigh up the advantages of selling early to ensure a profit over wanting more and talking the risk to cash in an important loss.
As you have seen, there are many strategies, all of which make sense in their own way. No matter what your trading capital and goals might be, you better have some exit strategies before investing. They are what will save your capital in the long term.
Which strategy you choose depends on you, but do make sure to choose some. The worse thing you can do is trade with your emotions and gut feeling. While they can be rewarding in some cases, they are also the cause of the biggest losses among beginner investors, so be smarter. Plan an exit strategy. Keep your money and do not gamble it under the orders of greed. Good luck !