We hear it all the time: “When should I sell my stock?” Sometimes, it’s because a stock performs poorly, and the investor is wondering if it’s time to jump ship. But other times, the stock is performing well, and it’s hard to decide whether the stock has reached its fullest potential. This post will explain how to determine when to sell a stock and what options you have moving forward.
When Should I Sell My Stock?
Basically, there are three reasons why you might want to sell a stock:
- Your stock is performing favorably, and you wish to profit
- Your stock is performing poorly, and you want to minimize losses
- You want to invest in different stock and need the funds
But while these motivations are clear enough, it’s not always easy to know the best time to sell a stock. After all, a stock may continue to perform well, and selling too soon could mean you miss out on increased profits. Likewise, there’s no foolproof way to know when a stock could rebound and rise to the top. Still, there are some general tips that you can use to optimize your investments, and it’s to these that we’ll now turn.
How to Decide When to Sell a Stock
Selling a stock isn’t an exact science, but that doesn’t mean you have to go with your “gut,” either. The following tips will demonstrate how to decide when to sell a stock.
You Reach Your Price Target
When you made your initial investment, how much did you expect to earn? It’s always wise to establish a price target (or at least a range) when you consider selling the stock. A reasonable price target will be if the stock doubles in value from when you initially purchased it. If you’ve reached this goal, this may be a good time to consider selling.
Your Stock Has Plateaued
As a basic investment principle, you don’t earn money from high-value stocks; you make money from stocks that grow. If your stock has stopped growing, that means you’re not earning any additional money. It may be time to scrap that stock and find one that you anticipate seeing growth.
You Want to Invest in a Different Stock
Of course, it could simply be that you want to invest in a different company, perhaps because you anticipate good future performance or even because you share that company’s ethical concerns. Whatever your reason, you might sell one stock to free up funds to invest in a different company.
You Notice a Drop in the Fundamentals
Don’t wait until the stock starts to drop. Monitoring your stock’s performance is critical, primarily when you focus on the business fundamentals such as profit margins, cash flow, and any significant changes in the company’s business structure (more on this below).
Following a Merger
Mergers are rarely successful, at least not from a short-term perspective. A merger can take many months to effectuate. And even if a merger goes smoothly, the company often undergoes a significant restructuring. By the end of the merger, you may discover that you’ve invested in a company you no longer recognize. While a merger may bring future success, you may be better off selling your shares and waiting to see how the company performs once the dust clears.
Following a Bankruptcy
Bankrupt companies offer nothing to shareholders. If a company declares bankruptcy, you need to sell your shares as soon as possible to minimize your total losses. Additionally, you can use this loss to offset future capital gains for tax purposes, so it’s essential to keep a record of what happened and when.
Following a Scandal
Scandals and fraud have a dramatic impact on the company’s public image as well as the company’s stock value. Sometimes fraudulent practices are telegraphed to the public through rumors and press leaks, which presents shareholders with a tough decision: Do you trust the company or trust the media reports? Keep in mind that some investors could spot the fraud at Enron before it happened and save money by selling their stock before prices indeed plummeted.
When Should You Sell a Stock for a Profit?
Keep in mind that the factors we’ve highlighted above aren’t mutually exclusive. In other words, you might make your decision based on a combination of these factors. For example, you might consider selling a stock for a profit if several factors are in play simultaneously:
- Have you reached your price target?
- Has your stock price stopped rising?
- Are there other stocks you want to invest in?
The best time to sell a stock is when you can say yes to at least two out of these three questions.
When Should You Sell a Stock at a Loss?
At the same time, it’s not always wise to sell a stock only because of a price decrease. During a volatile market, for instance, the price of an individual stock may fluctuate wildly, which can even reflect the behavior of stock investors.
The best time to sell a stock at a loss is when its overall trend seems downward, and you need to sell the stock to cut your losses. Rather than cling to the hope of a miraculous rebound, it may simply be time to cut your losses and invest in a different stock.
How to Know When to Sell a Stock: Decide Beforehand
Sometimes it’s wise to ask yourself beforehand, “when should I sell my stocks?” You can automatically set various types of stock orders to sell underperforming stocks. We’ll cover three common types.
Stop Order
A stop order is designed to sell a stock if it drops to a particular price. For example, if you invest in a company currently trading at $20 per share, you can place a stop order that will jettison your shares if they drop to $10 per share. As long as your stock performs favorably, this order will never be executed. But if the price plummets, you’re saved from more significant financial losses.
Keep in mind that this automated stock order won’t necessarily work this simply. In our above example, a stop order set at $10 per share doesn’t guarantee you’ll receive the full $10. The stock could just as easily plummet to $5 per share, which will be the price at which the shares are sold. A stop order simply determines the price at which a stock is sold.
Trailing Stop Order
A trailing stop order is simply a variation of a stop order. While a standard stop order relies on a specific market price, a trailing stop order hinges on the percentage of change in that price. So, in our above example, if you invested in a stock sold at $20 per share, you could issue a trailing stop order set at 10%. This would mean that if your stock price dipped by 10% (or more), your stock would be sold automatically.
Stop-Limit Order
A stop-limit order sets a stop order as well as a limit order. This establishes a range by which your stock is sold. Returning to our example, if you purchase a stock at $20 per share, you can issue a stop order that sells the stock at $10 per share, as well as a limit order that sells the stock no lower than $5 per share. So if your stock plummets to $7 per share, your stock is sold. However, if it drops to $3 per share, your stock will not be sold. This may sound a bit confusing, but it provides investors maximum control over their gains and losses.
Bottom Line: “Should I Sell My Stocks?”
There’s an art and a science to investing in stocks, and ultimately you remain in the driver’s seat. It’s rarely easy to decide exactly when to sell a stock, but you can at least establish an overall range with some careful planning.
Keep in mind that you should never use market volatility as a reason to jump ship. Long-term investors understand that sometimes there will be seasons of fluctuation, and sticking with it can ensure that you get the most from your investment throughout your lifetime.
Additionally, the changing dynamics of the stock market are a good reminder of why it’s wise to pursue a diversified portfolio. Diverse investments can shield you from substantive shifts in market prices and help you see a rise in your overall investments rather than focusing on individual stock prices.
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