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Knowing when to sell a stock is as important as knowing when to buy it. Savvy investors have a "sell discipline," or a set of conditions that will prompt them to sell stocks. Like most investment decisions, selling is part science, part art. Unfortunately, for many investors, however, it amounts to sheer panic. They sell when their stock goes down. They sell when the entire market goes down. They sell when they read that the ruble collapsed. In short, they sell for emotional reasons. Most investors are motivated by things such as fear
of loss and fear of regret rather than by rational decisions designed to
grow their money. These emotional, and irrational, decisions are just what
successful investors must avoid. Instead, you want a "sell discipline."
All that means is that you know which conditions will prompt you to sell.
A little later, we’ll go through the seven signs that you may want to sell.
What is your sell discipline? Those who follow the value investing strategy give an answer like this: "I buy a company when it's selling for 50 cents on the dollar and I sell it once it is fully valued at a dollar." The second answer comes from the growth school. They buy on momentum and sell when that momentum slows down. "Sell too early," so that you don't get caught in the downdraft. Well, these sell disciplines sound fine. But do they make sense for individual investors? Do they work for beginners and intermediates, or those who haven't built their own momentum models? Investors like me, for instance. And maybe like you. I don't think so. Buying a down-and-dirty value stock is intimidating enough. To do it, you must have the conviction that it's going to come back. Selling a value stock when it reaches full price means that you must know how to analyze the company so you can determine that price. If you're a growth investor, watching for a slowdown
in trading volume might be more doable. But that's for traders.
How then do the rest of us decide when to sell? Let's assume you’re a buy-and-hold investor rather
than a trader. You've put together a group of stocks that you expect to
hold for the long term because you think the companies have solid long-term
prospects.
Consider a business with a good story to tell, "one
in a good area with a management team that is
Your job as a stock investor is to decide when the
story changes. You have to avoid being trigger-happy.
Seven warning signs:- Look for these events as reasonable times to reassess a stock: The company changes management. The company is acquired or merges with another company. A strong new competitor enters the market. Several top executives -- known as company insiders -- sell large blocks of stock. You need to rebalance your portfolio to maintain your long-term investment objective. It could offer a short-term tax advantage. The stock surpasses its target price. None of these
reasons are grounds for selling simply because one or more of these factors
occurred. It just means you need to examine the company to determine if
it’s still
Let’s use a real-life example: Suppose you bought Pfizer (PFE). The introduction of Viagra sent that stock soaring. Then perhaps you picked up the paper one day and read that a handful of people died since they began taking the drug. Do you sell? No. The story hasn't really changed. Many of the people who use Viagra are older folks. There may be no connection. What if you buy Intel (INTC) and the competition seems to be weakening its powerful position in the chip business? The need for rebalancing. So you have to decide -- and if you’re a long-term investor you should err on the side of staying put -- when the story changes. You must also look at your own portfolio and make certain you still have the balance and diversity you want as your investments grow. Rebalancing offers a more interesting issue for long-term investors as they decide whether to sell a stock. What about a target price? Should you set a target price when you will sell? Many money managers do just that. They have a specific gain in mind when they buy the stock. When it hits that number, they sell. Others scoff at that. "The market tells you nothing," "It's simply the current vote by the irrational investor." One spin you might put on the target price strategy is to look at the relationship of the stock's price-to-earnings ratio to the market P/E when you buy. Suppose your stock is selling at 60% of the P/E ratio of the market as measured by the Standard & Poor's Index of 500 stocks. Maybe you decide that if it gets to 90%, you will sell. Finally, if you’re investing in a taxable account, you should look at your entire portfolio when deciding when to sell. A loss can be valuable because it provides a tax benefit that you can use to offset a gain. If you want to sell a stock that's too high -- to rebalance your portfolio -- you might consider selling a loser when you sell the winner. You get the point. You need to have a strategy in mind, something to guide you when the market dips and swirls. Then you can tell yourself why you are staying put.
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