Choosing a time to buy or sell stocks can be a tricky business. Even with so much attention placed on stocks by very knowledgeable traders, fund managers, investors, analysts, media personalities and academics, no one actually knows the best time to buy and sell.
This, of course, does not stop people from giving advice, whether officially or not. A vast majority of this advice is geared towards making investments. Naturally, this is because that’s how a vast majority of people earn their commissions and fees.
While people also incur some costs to sell off of their investments, they can only do so after they have made investments in the first place. The industry also tends to earn less money when people sell off their investments because it is common for financial institutions to charge a percentage for the funds they manage.
Why It Is Important To Know When To Sell
DollarsAndSense has often supported the concept of investing for the long-term. There’s no reason retail investors should behave like traders – going in and out of their investments within short periods of time.
While this is our view, we also think that it is important for investors to know when to get out of investments to ensure you preserve your long-term wealth and prevent devastating financial losses. This is often easier said than done as many of us will be swayed by greed and fear when it comes to selling off an investment.
Consider a scenario when a stock turns negative, our emotions may influence us to quickly sell it at a loss based on unfounded fears even though the company is fundamentally sound. However, this is exactly when long-term investors will actually be seeking to buy undervalued stocks.
An example of this was when Warren Buffett invested in Goldman Sachs during the 2008 financial crisis or when Temasek Holdings poured more money in Singapore-listed Olam International when it was the subject of reports stating it was in dire financial straits in 2015.
Alternatively, some of us could stubbornly hold on to losing investments because we don’t want to regret our decisions when it recovers. This could lead to hefty financial losses if the company nose-dives. This played out when another Singapore listed company, Noble Group, spiralled to a market value of $400 million today from its peak at $10 billion in early 2000s.
On the other hand, when we are sitting on profits, our emotions may lead us to selling too soon or not selling and eventually losing money as we held on to positions because we did not want to miss out on more profits.
These scenarios show that making these decisions are rarely straightforward. Very often, they are also purely fueled by emotions rather than understanding – which makes it critical for investors to know when they should sell.
How To Know When To Sell?
This is a question that investors often struggle with after buying stocks. As discussed right at the start, no one truly knows the best time to buy or sell an investment. However, you can take emotions out of the equation by putting investment strategies in place to guide your decisions.
We highlight four common ways to go about deciding when you should sell stocks.
1. Mistake In Identifying Stocks
One mistake that could lead to you selling off your stocks is when you wrongly identified an opportunity to invest.
This could be in your analysis of a company’s fundamentals or prospects in the market. It could be that you wrongly thought the airline industry would boom translating into greater revenue and share price for an airline company given its market share. Or, it could be that you rightly thought the airline industry would boom but it did not translate into a proportionately greater revenue for the airline company as it lost market share.
In either scenario, whether the share price of a company moves up or down, you made an error in your calculations when you decided to invest. You have to relook them and decide whether it still makes sense for you to keep your investments – no matter whether the share price has fluctuated up or down.
2. Setting Sell Targets
Another way to determine the right time to sell a stock is to set upward and downward sell targets. For example, you determine that you can stomach a 15% loss on an investment before it will start affecting your financial goals. This means that, regardless of the circumstances, you will sell your stocks if it loses 15% of its value.
This helps you to set a stop-loss and prevent getting mired in a situation where you may lose up to 50% or even your entire investment if a company runs into financial trouble or goes bust.
In the same token, you can also set sell targets for upward price fluctuations to take profit. While this does limit your potential to remain invested in the next Amazon or Apple of the world, which can go up by several thousand folds, you get to lock in your profits as early as possible. You also prevent a scenario where stock prices shift back to your initial price or lower.
Also, the chances of identifying another Amazon or Apple is really slim.
3. A Change In Fundamentals
Another way to determine the right time to sell is when the fundamentals in the companies you invest in change. This could be due to a change in balance sheet or even the amount of debt that the company is taking on.
Changes in management, M&As (mergers and acquisitions) and certain corporate actions can also alter a company’s fundamentals.
Another thing to take note of is that if the company used to pay out the majority of its profits in dividends but suddenly decides to reinvest profits into the company, it could mean that is changing the way it operates, which is a valid reason to re-evaluate your investment in the company. Similarly, if a company decides to pay out more of its profits as dividends, it could mean that it is finding difficulties growing the company.
If the company is shifting away from the reason you decided to invest in it, it should mean you critically relook your investment and sell it off if it doesn’t fit into your investment objectives.
4. Rapid Changes In Share Price
Rapid appreciation and depreciation in share prices could also be a trigger for selling your investments. When a company’s share price rises too fast, it could be for several reasons – it gained a significant new business, the market wrongly valuing the stock or even leaked insider knowledge – but the one reason it is usually not is that you were smarter than everyone else.
The main reasons you should re-evaluate your position in the investment is because either the company’s fundamentals has changed or the market is wrongly valuing the company. The same is also true when a company’s share price nosedives rapidly.
Re-evaluating Your Position And Rebalancing Your Portfolio
You should monitor your investments regularly to ensure you do not miss out on some of these events and fail to carry out the actions you have set for yourself.
Just because your investments trigger a potential sell scenario does not mean you have to immediately sell it. Take the time to re-evaluate your investment and decide if you should shift the goal posts due to a shift in your calculations.
The trick here is that you need to continuously gain knowledge to improve the way you invest. Of course, the rule of thumb still suggests that when in doubt, don’t change your strategy.