How To Know When To Sell Stocks
A strong case can be made that investing in stocks should be an important part of everyone’s long-term financial plan. With the growth of online trading platforms and the widespread availability of credible information from financial websites, social networking and media sources, it’s never been easier to buy and trade stocks.
Online brokers make buying stocks a simple and straightforward process. But before you jump into the market and start buying, understand how to evaluate stocks. Knowing when to sell stocks is just as important as knowing when to buy them.
How To Know When To Sell a Stock
There is a common investment mantra: “Buy low, sell high.” Unfortunately, the reality is that no one can precisely identify that critical moment when a particular stock has reached its peak or when a broad market sell-off is coming. The best thing you can do is stay as informed as possible.
The same principles apply when selling long-term stock. Just remember that for any stock you’ve held for more than one year, you will pay long-term capital gains tax on any profits you realize.
If you decide to sell, it’s important to know which months are the most profitable. Lots of people have theories. In fact, one of Wall Street’s most popular adages is “Sell in May and go away.” But it’s actually very difficult to predict the very best times to sell, and it’s probably better to stick with principles like the ones given here.
1. When Valuation Is High
A company’s stock price is based on a number of factors. Stocks can get ahead of themselves and rise to unreasonably expensive valuations. When that happens, it might be time to sell.
One of the most popular and effective ways to measure valuation in the stock market is the price-to-earnings ratio, or P/E. The P/E of a stock is calculated by dividing its stock price by its reported or projected earnings. A high P/E reflects a high valuation.
2. When Selling for Valuation
One effective way to know when to sell stocks is to determine if a stock has a P/E that is far above the average of its peers. If you own an automotive company like Ford and you notice that its P/E has become much higher than that of General Motors, it’s time to do some research to see if there’s a reason why.
If Ford cars are outselling GM cars, the high valuation might be justified. But if the P/E can’t be explained, Ford might have become overvalued, and investors should consider selling for valuation reasons.
3. When Rebalancing Is Necessary
Many advisors suggest that you decide on an asset allocation when you first set up a new investment portfolio. Your asset allocation is a guide that tells you what percentage of your portfolio should be invested in various asset classes, such as bonds or stocks. Over time, if one sector outperforms or underperforms the others, your predetermined asset allocation will become unbalanced.
For example, if stocks go on a tear, your original allocation of 60% stocks and 40% bonds can quickly turn into 75% stocks and 25% bonds. In a situation like this, rebalancing is advisable. In the above example, you’d need to sell stocks and add to bonds until your original allocation is restored.
4. When Market Sentiment Is Negative
Market sentiment, also known as investor sentiment, definitely affects how stocks trade. Understandably, negative events in the news can cause investors to feel bearish. When this happens, whatever the reason, the market as a whole might trend downward. In a time of negative sentiment, it can be difficult for any stock to go up in value.
Investors with a long-term outlook can afford to ride out short-term fluctuations, but if your time horizon is short, you might consider selling during market downtrends even if they’re only caused by negative market psychology. If you repeatedly find yourself having to dump stocks because of negative sentiment, you should probably consider reevaluating your overall asset allocation.
When market sentiment is bad, shareholders may wonder if they can sell a stock with no buyer. There are investment companies whose only job is to buy or sell stocks of publicly traded companies whenever the market is open. They are called “market makers,” and while they won’t promise that you can sell your stock for the price you want, they exist so you can always sell it.
5. When a Company Shares Bad News
If a company is growing, its sales and earnings are up, and they’re reporting nothing but good news, the share price tends to rise. Conversely, if a company shares bad news, the stock is likely to go down.
Long-term investors don’t need to worry about stock price fluctuations that are based on short-term news, but if a company’s long-term fundamentals have changed, it might be time to sell.
For example, if a company puts out a press release announcing that its dividend payout is slashed or that it has lost a key competitive advantage, it might be better to sell.
Key personnel changes can affect stock prices as well. For example, when Apple CEO Steve Jobs passed away in 2011, the company’s stock fell. Shares eventually bounced back as stockholders gained confidence in the new CEO, Tim Cook.
It’s smart to pay attention to news about companies you are invested in, but try to avoid making major decisions until you have the full picture.
6. When the Stock Has Done Its Part for Your Personal Financial Goals
When should you sell a stock for profit? If you’ve owned a stock for a while and it has increased dramatically in price, you may be hesitant to part with it. Don’t be.
Sometimes, a perfectly good reason to consider selling a stock is simply to make a profit.
For example, if you bought a stock with a goal of achieving a 10% return in a year and the stock shot up by 25% in a few weeks, you may want to think seriously about selling. Sure, the stock might continue to go higher, but, as long-standing market guru Jesse Livermore once said, “No one ever went broke taking a profit.”
Drastic outperformance by a single stock in your portfolio is also likely to throw off your asset allocation, which is another reason to sell and reallocate those assets.
Hindsight: Stocks That Would Have Made You Rich Today
7. When You Need a Tax Break
Nobody invests in stocks to generate losses, but there are times when selling for a loss can actually help you by reducing your tax burden. Selling underperformers also helps by offloading stocks that are doing nothing but dragging down your portfolio.
When it comes to selling losers, the good news is that the IRS allows taxpayers to offset taxable capital gains with realized capital losses. If you took a profit earlier in the year and are dreading the upcoming tax bill, you can sell stocks that are trading at a loss and at least partially cancel out the gain. The strategy is called “tax-loss selling,” and it can significantly reduce your tax burden while you shed your weaker holdings.
How Long Should I Hold a Stock?
Day traders often sell a stock just hours after they’ve purchased it. Long-term investors sometimes hold a single stock for decades. Your time horizon will be determined by your goals and the performance (or nonperformance) of the stocks you choose.
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Last updated: May 17, 2021