Choosing When to Sell Stocks is Hard
When to sell your stocks is a common but key question investors often ask. Regardless how well you identify investing opportunities or time the market, your profit (or loss) is only realized when equities are sold in the market (except cash dividends).
It should be noted that selling stocks can be more of an art than science because stocks are sold and bought for various reasons. Remember, in order for you to sell any stock at any price level, someone must buy it at the same price level. In other words, at any price level, some are willing to sell for some reasons and others buy for other reasons. So, there is no golden rule of selling. It mainly depends on your own situation and rules that you set up for yourself. In this article, I’ll share when and how I decide to sell.
Goal of Investing
Ask yourself this question: what is your goal of investing?
Haste Makes Wastes
Many people pursue “high risk, high reward”. But high profit comes with a “price”. Are you willing to risk all your money in order to receive high return? Many do.
One good example is lottery. With an odds of winning being only 1 in 175 million, every year millions of people “invest” in the game hoping for high returns. As we all know, most people don’t win lottery and end up with -100% return.
According to studies (like this and this), in the US, the poorest groups of people play lottery the most. Why do the people who need money the most literally throw money away in lottery (or high-risk speculation/gambling)?
One of the reasons is probably the urge to become rich fast, the same reason for many beginner “investors” to jump into options and penny stocks trading (to be fair, option is a good way to hedge portfolio risks if used correctly; but trading options only is speculation. According to this study, most individual option traders incur significant losses).
Grow Wealth with Patience
I don’t play lottery. I believe that nothing good in life comes fast. Even though high risk may bring high reward in some cases, good reward doesn’t have to have high risk. With the power of compound interest, good or moderate returns with low risk plus repetition can quickly turn into a phenomenal return.
In his classic Intelligent Investors, Ben Graham defines investment as “an operation which, upon thorough analysis promises the safety of principal and an adequate return.” In the same vein, Warren Buffett once famously said, “the number one rule of investment is don’t lose. The second rule is don’t forget the first rule.”
Moreover, even though investing inevitably involves risk, I don’t think high return can justify high risk unless you know what you are doing and can afford to lose money and still live a cushy life (such as multi-millionaire venture capitalists who can afford and am prepared to lose tons of money in investing in start-ups and hope one of them will be the future Google or Amazon).
Neither do I think high risk can bring high return in the long term. In another of my articles, it is showed that stocks that has high risk (measured in price volatility) in the long run generate lower returns than those with lower price volatility.
When to Sell
Now, let’s turn back to the theme question: when to sell. The answer to this question depends on the reason for you to buy a stock in the first place, a reason other than that you “think” its price will go up. This idea is taken from one of Peter Lynch’s lectures on investment. He said that if you don’t have a reason behind your buy, then you won’t know what to do when its price drops (stop loss or wait for price to bounce back). I’d even say, without a reason to buy or hold a stock, you won’t even know what to do when price goes up either because you will be afraid of selling too early.
My reasons of buying/selling a stock
I keep a record of the reasons for every stock I buy. As a believer of value investing, my top criteria for buying a stock are a stock is undervalued and the company has low likelihood of going bankrupt. The Sprout Undervalued Index is a great place to screen for candidates.
Besides value consideration, some stocks are bought for their dividends and stability, and others for long-term growth. Other factors taken into consideration include my own expertise about certain industries or economies, and research about the general economy (e.g. business cycle).
The reasons to buy a stock can be easily translated into selling signals. For a stable, undervalued dividend stock, when its price falls, I either ignore it or buy more for higher dividend yields because margin of safety and time is on my side.
When the stock price rises to a point where profit of selling exceeds two years of dividends, I’d sell (part of) my holdings.
For a “growth” value stock, in my experience, it usually takes 1 to 2 quarterly financial statements for the market to realize its true value. Given that the average annual return rate for the stock market is about 10%, I prepare to sell a stock (use trailing stop order) when its return exceeds that level.
I also regularly check if the stocks I have still fit the reasons I initially purchased them for. If one no longer meets the standards (such as declining growth, earnings, or increasing debt), then I sell it to stop loss.
Stock investing requires research, patience, and discipline (resist the temptation to take high risk just to become rich fast, and set up rules to protect your hard-earned money).