How To Know When It's Time To Sell A Stock
The rush of stock trading is a fascinating experience that's truly novel with each new position. Buying into new holdings brings a hopeful exuberance, while selling can complete the cycle, bringing profits pouring into your brokerage account. Trading strategies often involve index funds and ETF holdings, leading to a long-term buy-and-hold approach, but there will inevitably come a time when selling off positions is the best course of action.
It can be tough to determine when and how to sell assets for the best possible return. There's no crystal ball that can illuminate peak prices or predict sudden shifts in market sentiment, after all. Gut instincts and quite a bit of personal research play outsized roles in the decision to hold or sell shares, but there are a number of factors that you can track to help make this decision easier. Whether you're a P/E ratio obsessive or simply a stringent rebalancer, these features can help make the decision about what positions to close a little more streamlined. It doesn't have to be a massive decision-making process; in fact, buyer's remorse (or seller's, in this case) shouldn't factor into your strategy.
1. Trend trading (primarily in the short term)
Pattern recognition is particularly important for day traders and other short-term investors looking to take profits on as many of their positions as possible. Short-term traders are seeking momentum shifts that help them capitalize on a surging price (ideally before or right as it starts to move northward), and then sell as indicators suggest that price appreciation is stalling. This might be a lightning-fast turnaround that happens in a matter of minutes or hours, or it could be a medium-term strategy that sees investors hold assets for weeks or months before cashing out on the adventure.
This isn't a superb approach for long-hold traders, though. Moving averages, relative strength indices, and other technical analysis tools may be helpful in evaluating ongoing positional strength, but they won't help a trader looking to buy growth assets in an effort to keep them for the long term. Even so, many investors mix and match strategies and a few growth assets may be paired with short-term holdings for a quality blend of investment types.
For those looking to trade in shorter bursts to crystallize profits, momentum indicators like moving averages can be useful in smoothing out trends to signal when a stock appears to be overbought or oversold (highlighting the potential for an overvalued or undervalued asset). The best way to visualize these trending movements is with crossover plotting via two or more moving average time frames (perhaps a one-month and one-week pair).
2. You've crossed the long-term capital gains threshold
Another important indicator that it might be worth selling a stock occurs once you've owned it for a year. After this point, you'll pay long-term capital gains tax on the earnings rather than the short-term figure. Chiefly, for some earners the long-term rate will be zero while even low earners will have to pay a 10% premium on top of their sale to the IRS if the assets fall under the short-term tax rules. If you're able to hold stocks for a year before selling them, you can take advantage of the 0% tax rate as a single filer earning up to $47,035, while married filers get a 0% rate up to $94,050 in household earnings. This figure includes the earnings from your stock sale, of course.
Regardless of your investment strategy, it might be worthwhile to reevaluate the forecasted performance of any stocks you own on their one-year anniversary. Some may be ripe for a sale that nets you a tidy profit, while others may seem primed for continued growth. Owning shares for a year gives you an incredible tax advantage, though, so it's worth an evaluation at the very least. Selling shares frees up capital that can then be leveraged in another investment opportunity, so a stagnating company or an investment in one that seems to have naturally run its course can be parted with on the backs of a sizable tax boost once this timeline has been reached.
3. Company priorities, challenges, or outlook have shifted
Often, companies will reevaluate their strategy or priorities in an effort to remain competitive in their marketplace. Sometimes this signals an exciting new direction or market opportunity and can translate into an improved outlook for shareholders. However, not all changes are positive and sometimes a new competitor, altered priorities, or even souring analyst sentiment can spell disaster for a brand.
From time to time, it'll be worthwhile for investors to sell shares in companies that are going through a period of change. When new announcements come down the pike, it's always worth evaluating whether or not you believe changes in the market will help or hinder the brands you've invested in. The marketplace isn't a static entity, and so changes will take place on a regular basis. Sometimes, rapid alterations will throw multiple curveballs at one or more of your investments in short succession.
New government regulation, a crop of new competitors, or even a change in price structure that negatively impacts sales and overall profits can send a stock's value tumbling. Keeping up to date with these kinds of changes in your investments' marketplaces can help you determine if a newly hostile trading environment is taking form, creating conditions for a reduction in your position.
4. The shares have hit your price target
On occasion, you'll buy into a company with a price target in mind (as a result of your research into the brand and its market space) and it'll simply rise to that target over the following days, weeks, or months. Sometimes everything goes right with an investment. When this happens, you should sell — or at least seriously consider it — in order to close out your position at the targeted price point and enjoy the profits. Analytically, a price target is a threshold you hope or expect stocks to rise to. While targets can be renewed if new information comes to light, whenever an investment reaches a target, it has potentially grown all the way up to its expected ceiling of value appreciation in the current marketplace.
Any new investment position you take should be matched with the price target. For one thing, this helps to eliminate a sort of hope-and-prayer investment strategy that many beginner stock traders rely on. If you've done the legwork to create a price target, then you will have at least a baseline understanding about the company's financials and its medium- to long-term forecast for growth. Similarly, any stock that you expect to decline can be avoided through this early phase of research preceding a new purchasing opportunity.
5. Company value has cratered or stagnated
Finally, sometimes an investor will want to sell shares they've purchased because they got the call wrong. Some investors are fearful of selling at a loss, but this shouldn't be a deterrent, and can even offer a tax benefit if leveraged correctly. A drop in value alone isn't a great reason to sell a stock, but prolonged underperformance might be.
There have been many fantastically poor stock market picks in the past, including Jim Cramer's assertion that Bear Stearns was a solid performer just days before it went bankrupt and Warren Buffett's purchase of Dexter Shoe, financed entirely with Berkshire Hathaway stock. Even the most experienced stock traders get it wrong on occasion, and cutting your losses is simply a routine part of trading. Not all running losses should be abandoned, however. There will be times when the company underperforms in the short term but has serious upside over the long run and may be worth holding on to.
However, it's always worth inspecting the losers you've invested in to establish whether keeping them for a potential turnaround in value is a better use of the funds than an investment in something new. This opportunity cost analysis should become an integrated feature in your market strategy and while there's no way to definitively suggest whether or not any given stock should be sold when its value starts to decrease, there will be plenty of times when this becomes the right decision for you personally.