When to Sell a Stock - Your Stock Guide

Theoretically, the ability to make money on stocks involves two key decisions: buying at the right time and selling at the right time. To make a profit, you have to execute both of these decisions correctly.

Buying a stock is relatively easy, but selling it is usually a more difficult decision to make. If you sell too early and the stock goes higher, you risk leaving gains on the table. If you sell too late and the stock plunges, you’ve probably missed your opportunity. What’s an investor to do?

Many investors have trouble selling a stock, and sometimes the reason is rooted in the innate human tendency toward greed. However, there are strategies that you can use to identify when it is (and isn’t) a good time to sell.

Key Takeaways

When it comes to investing, the decision of when to sell a stock is often more difficult than deciding to buy it.
In general, there are some intrinsic reasons—related to the stock itself and/or the markets—to sell a stock, and some extrinsic reasons related to the investor’s finances and lifestyle. Occasionally, the sell decision may be triggered by a combination of intrinsic and extrinsic factors.
Emotion and human psychology can sometimes get in the way of making a smart decision, so stay attuned to the data (and not your feelings).

When To Sell Stocks

Selling a Stock Is Hard

Here’s an all-too-common scenario: You buy shares of stock at $25 with the intention of selling it if it reaches $30. The stock hits $30, and you decide to hold out for a couple more dollars in gains. The stock reaches $32, and greed overcomes rationality. Suddenly, the stock price drops back to $29. You tell yourself to just wait until it hits $30 again. This never happens. You finally succumb to frustration and sell at a loss when it hits $23.

In this scenario, it could be said that greed and emotion have overcome rational judgment. The loss was $2 a share, but you actually might have made a profit of $7 when the stock hit its high.

These paper losses might be better ignored than agonized over, but the real question is the investor’s reason for selling or not selling. To remove human nature from the equation in the future, consider using a limit order, which will automatically sell the stock when it reaches your target price. You won’t even have to watch that stock go up and down. You’ll get a notice when your sell order is placed.

When Should You Sell?

In general, there are some intrinsic reasons to sell a stock—i.e., reasons that are related to the stock itself and/or the markets. In addition, the investor may also have extrinsic reasons to sell; by extrinsic, we mean reasons that are related to the investor’s finances or lifestyle. Occasionally, the sell decision may be triggered by a combination of intrinsic and extrinsic factors.

Let’s look at some intrinsic reasons or factors first.

Intrinsic Reasons to Sell

When the initial buying decision was a mistake: Most experienced investors may have encountered this situation at some point. You’ve watched this stock—or more likely, a meme stock—make phenomenal gains on a daily basis, so you finally decide to suspend your disbelief and recklessly put in a sizable buy order for the stock. But as soon as you do so, you realize that you’ve probably made a mistake. The best course of action in this case is to sell the stock, even if it means taking a small loss on the trade. And to avoid making the same mistake in the future, resist the temptation to chase hot stocks that are running on fumes, as they may burn you financially.
When the price rises dramatically: Selling a stock merely because it has risen dramatically in price isn’t always the best course of action. In some cases, the price gains may be justified by the company’s underlying fundamentals (for example, its sales and/or earnings may be growing faster than investors’ expectations). But in other cases, the price may have posted exponential gains purely on speculation, or due to other reasons such as takeover rumors or a short squeeze. In such cases, the investor would be well-served by doing some research to try and ascertain the reason for the stock gains, and depending on the findings, either sell the full position or sell part of the position and put in a stop order to sell the balance if it trades below a certain price. The more that a stock’s short-term gains contribute to your overall portfolio, the more critical the sell decision. For example, if you bought 1,000 shares of a biotech stock at $5 per share when your total portfolio was worth $25,000, that stock constituted 20% of your portfolio. If, after three months, that biotech stock quadrupled on promising trial results while the rest of your portfolio is unchanged, it would now account for 50% of your portfolio. In this situation, it might be prudent to sell some of your shares and book part of the profits, because of the negative impact on your portfolio if the stock retraced most of its advance.

When a stock reaches your price target: Have you ever owned a stock that has been down in the dumps for years, but suddenly has a new lease on life and is now trading at your original entry price? If you promised yourself that you would sell the stock if it ever came back to your buy price, dump it without hesitation (you shouldn’t have been holding on to that loser for so long in the first place, but that’s a subject for another time). Similarly, if a stock reaches a level that it traded at all too briefly in the past, and you always thought that you would sell if it reached that price again, or would consider selling part of your position rather than regret another missed opportunity, then why not sell all of it?… Because of the next point…
When a stock trades at a technical inflection point: When a stock trades near—and then breaks below—a multiyear low, it often portends additional losses ahead. In this case, it may make sense to sell the stock as soon as the technical level is breached on the downside. Likewise, if a stock breaks through a key resistance level on the upside, it may signal more gains and a higher trading range for the stock, which means it might be advisable to sell part of the position rather than all of it. Technical analysts also watch stock price charts closely to identify other signals such as moving average crossovers.

When the fundamentals deteriorate: A stock’s fundamentals may deteriorate for any number of reasons: slowing earnings and/or revenue growth, increased competition, higher costs and lower margins, or simply valuation. The first such signal of deteriorating fundamentals may come from a company’s quarterly earnings report, or sometimes from “guidance” ahead of an earnings report. Market reaction to negative news from a company, such as an earnings miss or lowered forward guidance, tends to be swift and unequivocal, with the stock likely to plunge by double digits. In such cases, the investor needs to determine whether the deterioration in the stock’s fundamentals is temporary or permanent. Since this is no easy task, it might be preferable to sell and exit the position first, then evaluate if it should be bought back later.
When a rival company issues bad news: Often, the problems affecting a specific sector may be highlighted when a bellwether company in that sector reports an earnings miss. If you own stock of a company in that sector, consider selling it unless you are quite confident that your stock will not be affected by the sector’s woes.

When the market looks wobbly: This is no easy task, and is certainly not a suggestion to indulge in market timing, but there are times when the broad market looks overextended; at such times, it makes sense to cull the weaker names in your portfolio. In a financial earthquake, stocks of companies that have a heavy debt burden or a weak financial position might be the first to collapse.

Now, let’s look at some extrinsic reasons or factors.

Extrinsic Reasons to Sell

Financial reasons: This can include any number of reasons pertaining to the investor’s finances. For instance, a stock may have gained so much in proportion to the rest of the portfolio (as in the example of the biotech stock mentioned earlier) that the investor may need to rebalance it to bring it back in balance. Or the investor might wish to sell a stock to book a loss for tax purposes. Another reason to sell a stock could be because the investor needs cash to deploy in a competing investment, such as real estate. Such financial reasons are pretty potent ones to justify selling a stock.
Lifestyle reasons: Lifestyle changes also present good reasons for selling a stock. Younger investors might consider selling all or part of their portfolio to make a down payment on a house or buy a car. Investors nearing retirement might sell stocks to wind down the equity part of their portfolios and reduce their risk exposure. Parents may also sell stocks in tax-advantaged plans earmarked for specific purposes such as their children’s education.

Combination of Reasons

In some cases, the decision to sell a stock or stocks may be precipitated by a combination of intrinsic and extrinsic factors. For example, let’s say you lose your job because of a corporate restructuring and are a few years from retirement. You have been uneasy about the markets’ elevated levels and historically high valuations, but you previously felt little inclination to act upon it. Now, however, you would like to conserve your capital with the intention of using it in the business that you always dreamed of starting. In this case, your sell decision is justified by intrinsic reasons (your lifestyle change) as well as extrinsic ones (markets’ elevated levels /valuations).

FAQs

If the price of a stock that I hold plunges, should I sell it or buy more to average down?

It really depends on a number of factors, such as the kind of stock, your risk tolerance, investment objectives, amount of investment capital, etc. If the stock is a speculative one and plunging because of a permanent change in its outlook, then it might be advisable to sell it. But if it is a blue chip that has suffered a temporary setback, then averaging down is a strategy worth considering.

I like the long-term prospects for a stock in my portfolio, but I am nervous that it might fall in the short term. Is there an alternative to protect my downside instead of selling it?

Consider a put option, which gives you the right to sell the stock at a specific price for a period of time. Put options aren’t cheap, but neither is insurance.

Can I sell a stock on the same day when I bought it?

Yes, as long as you don’t make a habit of it. Otherwise, you might be considered a day trader. Day trading can result in substantial losses and is best left to experienced, well-capitalized traders.

When I sell a stock, after how many days will I receive the proceeds?

For most stocks, the standard period to receive the proceeds of a stock sale is two days; this is also known as the T+2 settlement period.

The Bottom Line

Any sale that results in profit is a good sale, particularly if the reasoning behind it is sound. When a sale results in a loss with an understanding of why that loss occurred, it too may be considered a good sell. Selling is a poor decision only when it is dictated by emotion instead of data and analysis. The key thing to remember is that once the sell decision has been made on the basis of thorough and rational research, the investor should neither look back nor experience “seller’s remorse.”

This article was originally published by Investopedia.com. Read the original article here.