Investing Basics: Know When to Sell a Stock
Selling a stock is an important decision – almost as important as the decision to buy. Unfortunately, while the world is full of buy recommendations, there is very little advice on when to sell.
Many investors make the mistake of holding onto losing stocks for too long. Sometimes they compound this error by selling their winners too soon. The results? A remaining portfolio of mostly poor performers.
Successful investors limit their losses and let their winners run. There are a variety of ways to do this; the more popular strategies include:
- Setting a predetermined sales price. At the time you invest, choose two prices, one below your purchase and another above it.
For example, at the time you buy a stock for $50 per share, prepare to sell it at $60. Set a low-side “sell” price, too, to limit your loss if the price falls. Where to set these prices depends upon your expected profit and the loss you can withstand if the stock price drops.
Sell the stock if it hits either of these “target” prices. You may reevaluate and change these prices, but only if there’s a compelling, legitimate reason to do so.
- Another technique uses “moving averages.” You can calculate various moving averages using different stocks and different time periods. These averages are plotted on a graph to reveal trends that help you determine when to sell.
- Monitoring business fundamentals. Yet another technique is to sell when the company’s fundamental business indicators begin to wane. A few of the important factors are earnings, market share, profit margin, and sales volume. You can obtain this information from the company’s financial statements and from newspaper and magazine reports. The idea is to sell when the stock becomes overpriced in light of these factors.
- Selling overvalued stock. The price/earnings ratio (share price divided by earnings per share) is one measure of a stock’s relative value. If the ratio is too high, the stock may be overvalued, and it’s time to sell. For example, if a stock has traditionally sold for 20 times earnings and it’s now selling for 40, it’s probably overvalued. Some investors compare their stock’s ratio to the ratio of the Standard & Poor’s 500, again as a measure of relative value.
- Earnings trends. You might use the company’s earnings to gauge whether the stock will perform well in the future. Some investors compare earnings to other companies in the industry or to the Standard & Poor’s 500. If earnings trail the others by a certain percent, then sell. Other investors compare current trends to historical earnings. Sell the stock if a company’s earnings for the most recent 12-month period are less than the previous 12-month period.
There are, of course, other techniques (and combinations of techniques). If you invest in stocks, be sure to give careful thought to what your selling strategy should be.
There is no consensus on which strategy works the best, but professional investors do agree on one thing: selling stock requires discipline. Any rational strategy is probably better than none at all. Pick one that makes sense to you and stick with it.
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