One of the most difficult aspects of investing is to know when to sell a stock. In fact, knowing when to sell may be a more difficult decision than deciding which stocks to buy and when. For example, if a stock you bought starts losing money, should you consider selling it? Is it a temporary setback—in which case you may consider doubling down and buying more—or an indication of even worse to come? How do you know?
Conversely, if the stock is making money, should you consider cashing in your profits and selling it? But what if you sell too early and miss out on even bigger future gains? That's called seller's remorse.
Agonising over when to sell a stock illustrates how big a role emotion can play in investor decision-making. The following suggestions try to take some of that emotion out of the sell decision.
Have An Exit Strategy
Just as you should develop a reason for buying a particular stock, you should also come up with scenarios in which you would consider selling it. For example, if the stock goes up 10% or 20%, is that the "sell signal"? Will you be satisfied with that gain and not look back, or will you kick yourself if the stock goes up another 10%, 20% or more? Consider setting a price target at which point you would sell.
Being satisfied with a gain, even a modest one, and not regretting it can take some of the agony out of the sell decision. There's an old saying: "You can never go broke earning a profit." There's also another one: "Pigs get fat, but hogs get slaughtered."
When you buy the stock, you need to determine what you are looking to get out of it. Is it a short-term speculation? If so, you should be satisfied if it hits your price target and take your profits. If you think it's a solid long-term investment, you can be more patient and willing to ride out any short-term paper losses if you believe in the stock's long-term value.
Likewise, the dilemma of whether to sell or not could be an agonising one. Are you worried that the gains you've realised could suddenly evaporate, or that you could lose even more money if the stock price keeps falling? If that's the case, it may be better to sell and cut your losses or take your profits and get some sleep.
Has The Reason You Bought The Stock Changed?
Most people buy a stock because they think the company's finances and business plan are sound and it stands to prosper over time. But consider these questions:
- What if that proves not to be the case?
- What if the company starts to stumble?
- What if new products fail to ignite sales?
- Are competitors stealing a growing share of its business?
Do some research to see if these are simply short-term setbacks or an indication of longer-term problems.
- If it's the latter, you may want to consider getting out. If you're not sure and already in the money, consider selling part of your holdings and keeping the rest.
- If the former, admit you may have made a mistake and consider selling before things get even worse.
It's better to lose a little now and chalk it up to experience than to hold the stock all the way to zero. Too many investors hang on hoping for a rebound that never materialises. If you sell now and the stock does rebound, you can always get back in again later.
Is Your Portfolio Out Of Balance?
If you've been lucky and you've made huge gains in a stock to the point where it comprises a huge proportion of your holdings, you may consider paring your position a little. Most investment experts advise periodically rebalancing your portfolio to maintain diversity and risk management.
For example, if you maintain a traditional 60-40 balance between stocks and bonds but a rally in stocks has pushed the ratio to 70-30, you may consider selling stocks to get it back to 60-40. This is particularly true if one of your stock holdings suddenly accounts for an outsized share of your holdings, say 20-25%. It can be overly risky to have too much of your portfolio riding on one stock.
Can You Do Better Elsewhere?
As part of your ongoing investment research, periodically check to see if the stock is performing well compared to similar companies in its industry. While you may be satisfied that the stock has risen 10% in a year, that's not an acceptable performance if other companies in the same industry are rising by 20%.
It's a good idea to track companies in the same industry, or an ETF that tracks companies in that business, to see how your stock is performing relative to its peers. If it's underperforming, you may consider getting out. If you like its market niche, consider swapping out of your investment and into one of the industry leaders or an ETF that covers the whole industry.
Do You Need The Money Now?
A very simple, and compelling, reason to sell a stock is if you need the cash for other purposes. Selling your winners versus taking losses on your losing stocks certainly makes cashing out a lot more palatable. After all, the point of investing is to have more money later on for something important, such as funding your retirement, a home purchase or education. At some point you're going to have to sell your investments to fund those things. Selling when you're ahead simply makes sense.
Knowing when to sell a stock can be one of the most agonising decisions an investor has to make, and it's often a lot more difficult than deciding to buy a stock. Emotion often plays a key role in the sell decision: will you miss out on future gains if you sell now? If you're currently in the red on a stock, is it just a temporary setback—and a buying opportunity—or a harbinger of worse to come?
The decision on when to sell should be part of your decision to buy a stock. If you know why you bought a stock, you should also know what you want to get out of it.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…