Despite the extensive research required before purchasing a stock, buying is often a trivial task. When it comes to selling, however, it’s always a struggle. On the one hand, you’re afraid that if you sell too soon, the stock will continue to increase, and you’ll have left a lot on the table. But, on the other hand, you’re anxious that if you wait any longer, the market could crash, and you’ll miss your chance to sell. While it’s generally not a good idea to sell a stock just because its price has risen or fallen, there are times when it’s absolutely okay to place one or more sell orders. Here are some of the situations when you should sell a stock:
In This Article
1. At your planned exit point
Earlier, I mentioned that extensive research is required before buying a stock. I have found that every time I bought a stock, just because someone else said it was a good one or just because the stock was rallying, I always had a hard time knowing when to sell it. I would either sell it too early because I had little confidence in it or sell it too late simply because I didn’t want to accept that I had made a mistake.
In each of those cases, I made those decisions because I didn’t have a clear and foolproof plan for the stocks.
An investor will always have a difficult time selling a stock if they never did their due diligence when buying.
That’s why it’s crucial to do a comprehensive analysis and develop a plan (also known as an investment thesis) for each of your stocks way before you buy them:
- Check out the stock’s valuation and determine its fair value.
- Identify both your entry and exit points before buying.
- When you’ve come up with such a plan, make sure to follow it to the letter.
Having a plan in place will counteract all the emotions that come with the decision to sell a stock. Just make sure you stick to the plan.
2. If you made a mistake.
A mistake does not constitute you buying a stock, and then it starts dipping. Stock prices fluctuate all the time, and a stock price falling is a regular occurrence in the market.
What constitutes a mistake is you buying a stock that you barely know anything about simply because someone else recommended it, or you succumbed to FOMO (Fear of Missing Out) after watching a stock make phenomenal gains over a few days.
An example of a mistake I made was buying SDC. I bought SDC this year after a massive dip but didn’t have an idea about the business itself. The stock had lost more than 60% of its value from its all-time high and got so cheap that I thought I was getting a bargain. Well, I was wrong. I didn’t look at its fundamentals or look at its financials.
Another unfortunate mistake would be using the wrong numbers to determine a stock’s valuation. Even the most experienced investors encounter this situation at some point.
In these circumstances, selling the stock is the wisest course of action, even if it means incurring a slight loss. And to avoid making the same mistake again, resist the urge to chase after hot stocks that are running on vapor since they may financially burn you.
3. When fundamentals change
You’d be quite mistaken to think that after doing your due diligence, creating a plan, and eventually buying a stock, your work is done. Not quite. You still need to keep up with the company’s quarterly performance to review whether the business is on track with your investment thesis.
A company’s quarterly earnings report or guidance could reveal that the reasons you bought the stock in the first place are no longer valid for any of the following reasons:
- The company is losing market share due to increased competition
- There’s a fundamental shift to the company’s business model that changes your projections.
- Key member(s) of management leave the company
- Slowing down of revenue or earnings growth.
- Increasing business costs and lower margins.
- New regulations that affect the bottom line.
Any negative news from a company, such as poor earnings or lower future guidance, often triggers a quick and severe reaction from investors. The stock is bound to experience a double-digit plunge in a matter of a few hours.
That’s why it’s essential to constantly keep an eye out for such events. Always listen to earnings calls and never miss an earnings report or a company’s guidance report. Because if something ever so slightly changes towards the negative, you’ll need to quickly determine whether this deterioration is temporary or permanent and thus promptly decide whether to sell.
4. When you’ve identified a better opportunity
As an investor, you want your portfolio to contain the best stocks you can find.
Suppose you encounter a fantastic purchasing opportunity for one of your favorite stocks and you’d like to buy it as soon as possible.
Ideally, you’d use your saved cash to make the purchase. But what would you do if you didn’t have the cash?
The next best option is to look at your portfolio and identify a stock that doesn’t have as much potential as the one you’d like to buy.
By selling such a stock, you’d be able to free up the cash needed.
Although there’s probably nothing wrong with this particular stock, seeing a good long-term opportunity elsewhere can be a compelling reason to sell.
5. When you need the money for personal reasons
While it’s never a good idea to invest money that you’ll need in the next few years, there might come a time when you need the money.
Our lifestyle changes all the time. For example, in the case of a young investor, you might need to sell part of your portfolio to raise cash for the downpayment of a house or a car. And for an older investor, you might want to reduce your exposure to risky investments like stocks and move towards bonds.
Another common situation when investors sell out is when they have children who plan to attend college, and so they’d like to raise cash for tuition fees.
When not to sell a stock
- When the price has increased: Don’t sell a stock simply because the price has risen. Winning stocks rise in value for a reason, and they also tend to continue to do so.
- When the price has decreased: Don’t immediately sell a stock because its price has dipped. Every investor wishes to purchase at a low price and sell at a high price. Selling a stock solely because its price has dropped has the opposite effect.
- To reduce your tax liability: Tax-loss harvesting is a tax strategy that some investors use to help you minimize their taxable capital gains by taking losses on underperforming stock positions. While it can be a useful approach for some investors, selling equities, even those at a loss, solely to lower your taxes is often a bad idea.