One of the challenges faced by traders and investors alike is in knowing when to sell a stock. After all, it's hard to let go of an asset that is making you money. Some who are new to the market may regret selling their stocks before they peak, missing out on major gains; others hold on to them for too long, in the hopes that a failing stock will rise again. How can you best decide when to sell?
For those who are just starting out in the market, you may be pleased to know that there are many clues that point to whether a stock should be sold or not. Here we cover things to look out for, and a few tools you can use to make the tough choice to hold or sell.
Caution in the Market
When traders think that an asset is about to start losing value, they often prefer to take the profit they know they have rather than face the chance of a loss. Although this inclination may seem to go against reason, it falls in line with trader behavior and with human nature, and it is how many people who play the market make tough choices. While it appears to be a smart and safe way to keep the value of your portfolio up (or, at the very least, steady), if given enough time, the stock market will likely rebound, which can continue a stock's winning trend.
Some would counsel to never sell winning stocks (those that may dip now and then, but rise in the long run), while others say to sell with caution. People in the latter group know to think bigger than human nature; they likely have a strict method in mind, and they will stick to that process before selling a winning stock.
Financial Ratios
If you have a stock that has had a good run, it's normal to be pleased, but don't drop your guard; instead, stay alert and look for any hints that it might start to decline. There are many signs that can tip you off to changes that could mean the price has started to head south. These signs can often be found in the form of financial ratios.
The health of a company that issues the stock can be measured through what is called a "fundamental analysis," which consists of a close audit of financial statements. Experienced traders, analysts, and other professionals will often use financial ratios to gain insights in an attempt to predict how well a company will do in a given time frame. Most companies keep a close guard on their financial details, and so the figures they use to compose these ratios can be hard to come by.
Note
Be mindful when using ratios to compare stocks. The way ratios are calculated can vary, so when looking at two or more stocks, make sure they are in the same industry and use the same internal accounting procedures.
If you can access financial statements, there are many figures you can look to for a greater sense of a stock's value, such as dividend yield, price-to-earnings (P/E) ratio, earnings per share (EPS), and dividend payout ratios. Other key ratios that can be used to deepen your knowledge of a company are debt to equity, the quick ratio, the current ratio, or other liquidity measures (how quickly it can turn assets into cash), and solvency ratios (how quickly it can pay off debts).
Target Prices
Many traders set a floor on a stock's price so that if it falls below a certain level, they sell it to maintain a profit. You can also set an upper limit that would trigger your sale.
Your logic here might be that you fear the stock will have a hard time supporting a market price above a certain level and that a hint of bad news might send the price into a nosedive. Setting limits on when to sell and when to buy ahead of time can help temper your fears.
Some traders simply say, "I want to make X amount of return; when I hit that, I'm going to sell and move on to another stock." This mindset can allow you to keep feelings out of your trades so that you act with prudence. Over time, this type of trading may reward you with higher profits, since you will be less likely to sell too soon or engage in panic-selling.
Reduced Dividends
When companies start cutting back on dividends, or even cutting them fully, it's time to take a hard look into their internal workings. As an investor, you should be checking the monthly and quarterly performance of the companies that issue your stocks. Pay close attention if a company cuts dividends, which might hint at a serious event, and it could be a sign of cash flow trouble or other changes or issues that could affect the value of the stock.
Note
Dividend stocks offer payouts to shareholders at steady intervals. People who invest in dividend stocks are hoping to make income on a regular basis and to see growth in the long term.
Note that companies do not have to pay dividends. When dividends are cut or reduced, it's not always a clear sign of a financial problem. A company might be putting funds back into retained earnings or using the money for research and development instead.
In sum, dividend cuts are not always negative, but if you are only in stocks for the steady flow of income, they may signal the best time to sell stocks.
Lower Trading Volume
If a stock is suddenly trading at a lower volume than before, it might be a sign of trouble. Stock liquidity is a measure of how quickly a stock can be bought or sold, and it's a crucial factor for traders wishing to sell their stocks that are not doing well. If you cannot sell your stock because there are no buyers, you'll have to hold on to it, even if it swings down, and hope the company can get through the tough times.
Strategies for Selling
It helps to look ahead and at the bigger picture when thinking about selling your stocks. If you have an eye on the context of the market (and even of events outside of the market) that might affect stock value, you'll have a more informed view of the need to take action.
Look Out for Media Hype
If a stock you own becomes the focus of media hype, it may be time to consider taking a profit. These types of stock-feeding frenzies attract many types of people to the market, including brand new players, well-versed speculators, and people looking to make a quick buck. The result of quick buys at a faster rate is often a stock price increase. However, when the prices get too high to draw the sharks, stocks can collapse: the hype dies, prices fall, and you're left with a negative return on your investment.
Note
As the name implies, a speculator is a type of trader who tries to predict and seek out stocks that may be due for a boom; they buy and sell quickly, taking a lot of risk in the process, but also helping to keep the market in motion.
Stagnant Growth Stocks
Growth stocks are expected to grow. When they stop growing, or when growth begins to slow, it might be the best time to sell. Traders do not look kindly upon growth stocks that fail to maintain their growth.
Don't Sell All of Your Holdings
Place part of your holdings off the table. If you have a good profit in a stock, think about selling only a portion of your shares. You can reinvest the profits into other stocks that are doing well, and let the others stay as they are. That will help to spread the risk over a wider array of assets while still making a profit. If the stocks you keep begin to flounder, you can sell them and, ideally, get out with some profit.
Be Mindful of Trading Too Often
While the goal is always to make the most gains on your investments, don't forget to keep an eye on the back-end costs that come with each sale. Brokers make money by charging a fee for each sale, and if you sell too often, you can eat into your profits by running up a large broker's bill. A few smart trades will beat a dozen second-rate trades any day.
Frequently Asked Questions (FAQs)
Should you ever sell stocks at a loss?
It's usually a bad idea to sell stocks at a loss unless it's part of a pre-determined trading plan. For instance, you may enter a trade with a specific profit target and a stop-loss at your acceptable risk level. In this case, your stop-loss order may sell your stocks at a loss, but that's okay because it was the risk you accepted before entering the trade. It's best to enter each trade with a plan and stick to that plan unless something significantly changes about the underlying business.
When should you sell bonds?
Bond traders seek to sell bonds when interest rates are expected to rise. Rising interest rates push bond prices down, so capital gains are maximized when interest rates are at their lowest point. However, bond price fluctuations don't affect interest payments for investors who decide to hold bonds to maturity. If you're happy with your current level of income, and nothing has changed about the bond issuer's creditworthiness, then there's no pressure to sell at any time.
