You may think owning stocks is all about making money. Granted, your goal might be capital appreciation, but if your losses exceed your gains, your efforts will be in vain. Priorities should be set high for risk management, capital preservation, and fast loss taking.
Making money in the stock market requires two crucial decisions: buying at the right time and selling at the right time. While buying the right stock is important, knowing when to sell is equally crucial to maximizing your profits and minimizing your losses. This article explores six key factors to consider when deciding whether to sell a stock.
1. Cutting Losses Short: The 7%-8% Rule
The first and foremost rule, as emphasized by William O’Neil founder of Investor’s Business Daily, is to sell a stock when it falls 7%-8% below your purchase price regardless of the reason for the decline. This rule is designed to limit your losses and prevent emotional decisions that could lead to holding onto a losing stock for too long.
Here’s why this rule is so important:
- Limiting losses: By selling early, you prevent further losses that could potentially snowball and significantly impact your portfolio.
- Avoiding emotional decisions: When a stock starts falling, it’s easy to get caught up in the emotions of fear and hope. This rule helps you make a rational decision based on a predetermined threshold, rather than letting emotions cloud your judgment.
- Freeing up capital: Selling a losing stock frees up capital that you can reinvest in other, potentially more promising opportunities.
Remember, it’s better to take a small loss early than to hold onto a stock that could potentially lose much more value.
2. Quick Gains: Don’t Be Greedy
While it’s tempting to hold onto a stock that’s rapidly increasing in value, sometimes it’s wise to take your profits and run This is especially true if the price increase seems unsustainable or driven by speculation rather than solid fundamentals
Here are some situations where selling after quick gains might be the right move:
- Short-term catalysts: If the price surge is due to a short-term catalyst, such as a takeover rumor or a short squeeze, the gains may not be sustainable. Selling after the catalyst fades can help you lock in your profits.
- Overvalued stock: If the stock price has risen significantly beyond its intrinsic value, it may be at risk of a correction. Selling before the correction occurs can help you avoid potential losses.
Remember, taking profits after a quick gain is not the same as missing out on further gains. It’s about managing risk and ensuring you don’t give back all your profits in a sudden market downturn.
3. Price Target: Know Your Goals
Many traders use price targets to guide their selling decisions. A price target is a specific price at which you plan to sell a stock, regardless of whether it’s above or below your purchase price. Price targets can be based on various factors, such as:
- Technical analysis: Traders may use technical indicators to identify potential price targets, such as resistance levels or moving average crossovers.
- Fundamental analysis: Investors may set price targets based on their analysis of a company’s fundamentals, such as its earnings potential or growth prospects.
Having clear price targets can help you avoid emotional decisions and stick to your trading plan.
4. Technical Analysis and Fundamentals: A Holistic Approach
Technical analysis and fundamental analysis are two valuable tools that can help you decide when to sell a stock.
Technical analysis: This approach focuses on studying historical price and volume data to identify patterns and predict future price movements. Technical indicators, such as moving averages and relative strength index (RSI), can help you identify potential selling points.
Fundamental analysis: This approach focuses on analyzing a company’s financial statements, management team, and competitive landscape to assess its intrinsic value. Deteriorating fundamentals, such as declining earnings or increasing debt, can signal a potential sell signal.
By combining technical analysis and fundamental analysis, you can gain a more comprehensive understanding of a stock’s potential and make informed selling decisions.
5. Company News and Market News: Stay Informed
Staying informed about company news and market news is crucial for making timely selling decisions.
Company news: Negative news about a company, such as an earnings miss or a product recall, can often lead to a sharp decline in the stock price. By staying informed about company news, you can anticipate potential sell signals and react accordingly.
Market news: Broader market conditions can also impact individual stock prices. For example, a market downturn may lead to a sell-off in certain sectors, even if the company itself is performing well. By staying informed about market news, you can make informed decisions about whether to hold or sell your stocks.
6. Cashing Out or Change in Lifestyle: Personal Considerations
Sometimes, selling a stock may be driven by personal considerations rather than market factors. Here are a few examples:
- Cashing out: You may need to sell a stock to raise cash for a down payment on a house, pay for unexpected expenses, or simply diversify your portfolio.
- Change in lifestyle: As your life circumstances change, you may need to adjust your investment strategy. For example, you may sell stocks to reduce your risk exposure as you approach retirement or to generate income to support your children’s education.
It’s important to consider your personal financial goals and circumstances when making selling decisions.
FAQs: When Should You Sell a Stock?
Q: Should I sell a stock if it plunges and then recovers to my entry price?
A: This depends on your risk tolerance and investment goals. If the stock is a speculative one and the plunge was due to a permanent change in its outlook, then selling it might be the best option. However, if it’s a blue-chip stock that has suffered a temporary setback, then averaging down (buying more shares at the lower price) might be a viable strategy.
Q: Can I sell a stock on the same day I bought it?
A: Yes, this is called day trading. However, day trading can be risky and requires significant experience and capital. It’s best left to experienced traders who understand the market dynamics and can manage risk effectively.
Q: How long does it take to receive the proceeds from a stock sale?
A: For most stocks, the standard settlement period is two business days. This means you will receive the proceeds from your sale two days after the trade settles.
Deciding when to sell a stock is a complex process that requires careful consideration of multiple factors. By following the six key factors outlined in this article, you can develop a comprehensive selling strategy that helps you maximize your profits and minimize your losses. Remember, there is no one-size-fits-all answer to the question of when to sell a stock. The best approach is to consider your personal circumstances, risk tolerance, and investment goals, and make informed decisions based on a thorough analysis of the market and the individual stock.
When To Sell And Take A Loss
The IBD founder William Neilsen states that the general rule for how to make money in stocks is that you should sell a stock when you are 7% or 8% below the purchase price, with no exceptions. Setting up a rule in advance can help avoid an emotional decision to hold onto something for too long.
It should be: Sell now, ask questions later. Limiting your losses to 7% or even less will help you avoid getting caught up in significant market declines.
If they don’t sell their shares, some investors might believe they haven’t lost any money. In order to break even, they hang on in the hopes that it will rise again. If the current price is less than your purchase price, it is still a loss.
The rhetorical question is: How low can it go? Well, it can go all the way to zero.
If the answer is no, sell the stock. Consider this: Would I buy this stock, right now, right here? According to ONeil, the time you spend hoping it will return is an opportunity cost for using the money somewhere else.
It Takes More To Come Back When You Sell A Stock Too Late
A stock has more ground to recover the lower it drops.
If you bought a stock for 2010 and it drops to 90, that is a 2010 point drop, which indicates a 2010 percent loss. It appears that in order to get back to even, you need to make up 10 points. But that same 10-point move now represents 11. 1% of the now-90 stock. Therefore, you need to have an 11. 1% gain, not just 10%.
Should it decline even further to 80, that 2020 move equals a 5.25% gain that you have to attain in order to break even, and so on. The percentage decline accelerates as you lose more.
You can see how this can get ugly fast. Stopping the bleeding, cutting your losses, and moving on are crucial.