Obviously, if everything you needed to understand when to buy or sell a stock could be boiled down to a single article, everyone would be rich. The truth is that there’s no simple answer when it comes to when you should buy into an investment and when it’s time to bail. For every strategy or rule of thumb that seems to work most of the time, there’s going to be that time when it doesn’t and costs you a fortune in the process.
That said, some adherents to the idea of “technical trading,” have made it their goal to closely follow stock charts to suss out some basic patterns that can help pinpoint those moments before a stock is going to start climbing or falling. It usually boils down to group psychology, understanding what investors are most likely thinking and how you can use that to your advantage.
These patterns do have their downfalls — most notably that they don’t factor the actual companies in question into their calculations — but they can provide an active trader with some additional tools. Learn stock trading techniques that will help you predict when a stock is about to tank and when the next one might be on the verge of breaking out.
When a Stock Finds a Support Level: Time to Buy
At a certain point, a stock’s price will fall far enough that it becomes too much of a bargain for people to pass up. Imagine that used car sitting outside your neighbor’s home. Eventually, when the sign reads “For Sale: $5,” someone’s going to drive off with it no matter how many raccoons are living in the trunk. In stocks, that’s what’s known as the “support level” — that price at which investors see too good a price to pass up.
So, if company A always seems to recover before it dips under $10 a share, you could keep an eye on the stock, buy when it’s near $10 and see if the support level holds and the stock goes up in value.
When a Stock Finds a Resistance Level: Time to Sell
The other side of a support level is what’s known as a “resistance level,” which is a price where other investors tend to decide the stock price is getting inflated and it’s time to sell. Because, after all, even a raccoon-free Ferrari still isn’t worth it when the price tag hits $1 million. And if the going rate for a used Ferrari is $1 million, a lot of Ferrari owners will probably start deciding it’s time to sell no matter how much they love their car.
So, if every time Company B gets close to $20 a share it starts to fall again, it might be a sign that that’s the resistance level and you could consider selling as soon as the stock climbs close to that point.
Double Bottom: Time to Buy
A “double bottom” chart pattern is one where a stock’s price has fallen to a support level, recovered, started to fall again and then bounced off of the support level a second time — usually in a relatively short time frame. Stocks that have just found a double bottom can be on the verge of a solid run because it would appear to indicate that the support level is an especially strong one. Investors can then feel more confident that their potential losses are limited by that support level, making the stock appear to be a low-risk buy.
Double Top: Time to Sell
Once again, the double bottom has a counterpoint in the “double top.” It’s the exact same concept, only applied to a stock that has climbed to a certain price twice only to be beaten back. And likewise, it can be a real sign to traders to stay away as the stock would seem to have limited potential for gains but a larger potential for losses.
So, if Company B can’t seem to break past $20 a share twice in a relatively short time frame, it could really put the damper on investor enthusiasm and lead to a bigger downswing for the stock.
If Its Relative Strength Index (RSI) Shows It’s Oversold: Time to Buy
Many traders like to look at a metric called the relative strength index (RSI) to get a sense of how much momentum is behind a stock at a particular moment. The idea being that negative or positive sentiment around a stock can build to a fever pitch and push the price past the point where it makes sense, sparking a reversal of fortunes.
Calculating RSI is a little complex, but it essentially takes the average gains and losses of the last 14 trading days and produces a number from 1-100. Any time the RSI dips below 30 it’s considered “undersold,” and it’s often seen as a sign the recent downswing has gone too far and the stock is due to bounce back.
Check this out: 20 things to do in a falling market
If Its RSI Shows It’s Overbought: Time to Sell
Much like a few weeks of relentless declines can lead investors to think the markets are being too hard on a stock, too much enthusiasm can lead people to feel a stock is “overbought” and due for a fall. Traditionally, a stock with an RSI over 70 is viewed as overbought and could be in store for a decline.
After a Golden Cross: Time to Buy
One way to look at a stock’s performance is to use what’s known as a “moving average,” the averages of share prices over the last 20, 50 or 200 trading days. This can smooth out some of the daily ups and downs to give you a longer-term outlook.
And one of the important indicators many traders will look at is when shorter-term moving averages pass the longer-term ones. It’s a way of identifying when the more-recent market action for a certain company is significantly better than the longer-term, potentially identifying it as a hot stock on the rise.
So, say Company A had a 50-day MA of $15 and a 200-day MA of $20 until it went on a huge two-month tear that pushed the 50-day MA to $25 while the 200-day MA only hit $21. Many traders will see the moment when that 50-day MA “crosses over” the 200-day — what’s called a “golden cross” — as the right moment to buy shares.
After a Death Cross: Time to Sell
Not only does the opposite action — the 50-day MA going from higher than the 200-day MA to lower — have the opposite effect, it even has a pretty foreboding name: the “death cross.” Notably, a death cross in the major stock indexes has preceded most of the worst bear markets since the Great Depression.
When Insiders Are Buying: Time to Buy
In order to protect the general public, the directors or executives of public companies — along with anyone who owns a large enough stake in the stock — have to report any and all transactions involving the company’s stock to the Securities and Exchange Commission, which in turn shares them publicly so every investor can know.
Insider selling isn’t necessarily a bad sign. Whether it’s a kid going to college or a new yacht, executives might have any number of reasons unrelated to the company for needing some cash.
Insider buying is usually a pretty strong sign. After all, these are the people with intimate knowledge of company operations deciding that they think the stock is a good buy. As such, many traders will consider buying if there’s a significant jump in insider buying activity.
When Your Investment Thesis Changes: Time to Sell
Before you buy into any stock, it’s a good idea to be sure you have an investment thesis in place. That might be as simple as “Boy, these iPhones are great. I’m going to buy Apple!” But that also means, if Apple abruptly discontinues the iPhone, it’s time to sell (actually, that’s probably a good time to sell Apple stock regardless of your original investment thesis).
More practically, if you bought into a stock because you thought it was a tremendous value at $10 a share based on how much money the company was making and now it’s $50 a share without having significantly improving profits, it might be time to take your $40 a share profit and move on to the next investment.
Right Before a Short Squeeze: Time to Buy
Short-selling is a way of betting if a stock is going to fall. You sign a contract that grants you ownership of someone else’s shares for a set period of time. You can then sell those shares and — if the stock falls — buy them back at a lower price before you need to return them, netting a profit for yourself. If you’re wrong, though, the price goes up and you’re forced to buy more expensive shares to meet the terms of your deal.
This can produce what’s known as a “short squeeze.” If a stock keeps going up, the “shorts” can start getting nervous about how much it will eventually cost them to buy back the shares they need. If a lot of them decide to pull the ripcord and buy before their losses get even bigger, it creates a flood of people buying shares, boosting demand for the stock and driving the price even higher. And if the price increases, more traders who short panic and buy shares, which increases the price even more, which causes even more panic and so on and so forth. Bad news for the shorts, but downright terrific news for traditional investors who own the stock.
You can look up a stock’s “short float” — a metric that shows what percentage of its shares are involved in these short bets — to get a sense of how many people are shorting it. A stock with a steadily climbing price and a high short float could have a lucrative short squeeze on the horizon.
If the Short Float Is Too High: Time to Sell
Of course, that doesn’t mean that simply going out and buying up stocks that a lot of people are shorting is a good idea. To the contrary, shorting a stock is a relatively sophisticated strategy, so it’s safe to assume that the people doing it probably have their reasons. If a stock you’ve invested in has a high short float — not to mention, one that keeps increasing — it’s probably worth doing some research into what might be motivating all these people to bet the stock is going to go down. And, if you think their reasoning is pretty sound, that might be a sign to move on.
If Analyst Sentiment Is Strongly Positive: Time to Buy
Investment banks will often hire analysts to give recommendations on specific stocks. These are finance experts who are dedicated to learning everything there is to know about a particular company and its industry. They’ll usually issue a recommendation about the stock in addition to a “target price,” what the “right” price for the stock is based on their research.
This is not to say that these analysts are always right. They frequently can’t even agree with each other. However, if there does appear to a general consensus among several of the analysts that the stock’s worth a lot more than its current price, that could be a sign to buy.
When Analyst Sentiment Is Strongly Negative: Time to Sell
Of course, when analyst opinion appears to be forming a consensus that a stock you own is overpriced or has an underperforming business behind it, that can be a pretty good sign it might be time to move on.
The one important thing to note is that analysts will often be loathe to actually put a “sell” rating on a stock, frequently opting for something more neutral to avoid a flood of angry mail from investors. So, even if analysts aren’t screaming that a stock is worthless, if the target price is consistently only slightly higher than the current price, that might be a sign that there’s less upside than you want in your investment.
Buy and Sell Signs Can Help, But They Can’t Replace Smart Research
As important as it can be to know the sort of buy and sell signs often motivate traders and investors — and this is just a sampling — it’s equally important not to let these factors replace the sort of research into the underlying companies that really matter. After all, there’s no resistance level that’s not one great earnings report away from evaporating overnight. Likewise, no matter how oversold a stock might look based on its RSI, if news breaks that the CEO has been arrested for cooking the books for the last decade, well, it’s going to be even more oversold.
If you really enjoy trying to buy in and out of stocks at just the right moment, technical trading might be for you. However, if you’re a retirement investor who’s primarily concerned with padding your 401K, these short-term strategies probably aren’t going to produce your desired results. The age-old Buy-and-Hold strategy of investing in strong companies and holding onto those investments for years — ignoring chart patterns and technical indicators the whole way — is most likely going to have the best results in the long run.
After all, never forget what Warren Buffett famously said about his own investments: “Our favorite holding period is forever.”
Click through to read the warning signs of a bad investment.
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About the Author
Joel Anderson is a business and finance writer with over a decade of experience writing about the wide world of finance. Based in Los Angeles, he specializes in writing about the financial markets, stocks, macroeconomic concepts and focuses on helping make complex financial concepts digestible for the retail investor.