When to sell winning and losing stocks
Nowadays, it is so easy to buy stocks online through online brokers. In some cases, it has become terrifyingly easy to buy individual stocks for a novice investor. The general advice for new investors is to stick with more diversified and less risky investment assets such as ETFs. Stocks are never meant to be traded for short periods of time as they do tend to be volatile. There is a saying from Warren Buffet that reads:
If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minute
Which makes a lot of sense. Because when you get ready to invest in individual stocks, you need to be able to answer some questions about the company you are investing in:
- How informed are you about the core business and revenue model of this company?
- How do you see their current product or service line and what is the prediction about its potential future?
- How well is the company ran by a management team that is committed to innovation and profitability as well as good business ethics?
- How healthy are the company's financial health, sales growth, and track record for meeting earning expectations?
You do need to have at least a general answer to the questions above and in an ideal scenario, be familiar with company performance, practices, and potential future to be able to make key decisions when the stocks are either:
- exceeding the expectations (which might encourage you to sell the stocks for sweet profit)
- or falling down in value and not meeting projections (which can tempt you to sell the stocks to prevent further loss)
And those are the two scenarios that we are trying to find some strategies for. But remember that you need to know the company behind the stock to some extent; otherwise, you are just getting caught in the gambling and speculation business, not being able to make key decisions when the time comes.
Should I (and when to) sell winning stocks
The past does not predict the future, but the stock market tends to move to the right side of the charts and yield positive returns over the years. Although many stocks could experience slow and steady growth or even tank, there are few stocks that could produce the majority gain of a portfolio. These are winning stocks like Amazon, Microsoft of Netflix which yielded 100X returns back in their time.
Spotting these stocks is a factor of very high-quality businesses with great management, vision, financial health, and a drive to deliver value to both customers and investors. But setting a portion aside for luck is also inevitable as the timing to the market or the role of external players cannot be ignored in the success rate of a company. But if we imagine that you are able to pick a winning stock based on all the available data (as well as having luck on your side) means that few stocks will be driving the majority profit of your portfolio, which is a bit scary.
If a stock keeps going up (which is a good problem to have), at some point you need to ask this question:
When is the right time to sell this stock? Or should I even do that?
And the answer is going to be partially boring: it depends
And it makes a lot of sense. Because the stock market is not inherently predictable. if it was, everybody could buy/sell at the right time and make a lot of fortune. So when it comes to selling a winning stock, consider the below factors.
DON'T SELL a winning stock if:
- There is a drop in the price of the stock or just a downturn in the market. Remember that the stock market in the short term is full of emotional people who are just increasing/decreasing the value of stocks due to speculation, but stocks tend to stay true to the economic output of the underlying business in the long run and hopefully increase the wealth in the economy which in turn benefit the value of the stock as well. So if the base value proposition and business model of the company still holds, don't get scared by sudden and short-term dips in the price of the stock.
- The company keeps growing in terms of sales, revenue, and marginal profit. Some businesses tend to have a ceiling when it comes to their price valuation, but if the company keeps innovating, maintaining a healthy balance sheet, and keep up with new product and service cycles in the market, there is a high chance that the company's stock keeps growing in value. If you truly believe in the company's mission and having a close eye on its business practices and financial data, then selling stocks at an early stage could be a disadvantage for your portfolio.
SELL a winning stock if:
- If you don't necessarily have a very long-term view of your investment portfolio and looking to cash out profits if they reach a certain level. A possible scenario is that you set a target profit percentage on the stocks that you buy, and either manually or automatically sell a portion or majority of the stock after it reaches that target. This is a disciplined way of looking at investments which might get a bit of lower profit if the stock keeps going up, but on the other side, it protects the money from price decreases as well.
- You need to have access to a more liquid asset like cash instead of stocks for an unexpected expense. It is always recommended that if you plan to use an investment in a short period of time, stay away from stocks as they tend to be volatile. But sometimes we need to sell our winning stocks if we need the money for personal reasons such as the loss of a loved one, new baby, or sudden move to a new place. Even though it might not feel good to sell a winning stock due to unexpected events, sometimes it is inevitable.
- You need to gradually rebalance your assets for an upcoming and known expense which requires you to sell some of your winning stocks. For example, you might be looking to buy a new house which can require to have more cash at hand to negotiate mortgages with banks, or your retirement age might be approaching and you might be looking to allocate more of your stocks into more liquid and less volatile assets such as cash or short term bonds. Since these expenses are expected, you can be prepared and plan to correctly sell off your winning stocks at the right time and in the right portions.
Should I (and when to) sell losing stocks
The decision to sell a losing stock could be considered easier than selling a winning stock, but it is still hard to know when to call it off and trim that stock from your portfolio. Even though it is not right to panic as soon as there is a dip in the stock's price, it is worth analyzing stock performances and companies behind them, in the long run, to see if a stock is actually on a losing trend or not. I see two scenarios for when to sell a losing stock.
- Consider selling a stock if it keeps dropping in value while something fundamental has changed about the business. It is important to distinguish between a short-term or permanent effect on a business. Every stock can go into cycles where it sees its stock price drop due to external factors that has nothing to do with the business. On the same note. a business can keep losing its value because the underlying business model is no longer valid, or if the company is suffering from bad operational and financial management, or if is facing fierce competition from move innovative and leaner competitors. The main reason you need to be involved with your investment companies is to have enough knowledge and background to make critical buy/sell decisions without making it look like a toss of a coin.
- Consider selling a stock if you want to have certain exit strategies for all your investments, no matter what. In this way, you will always consider selling all or a portion of your stocks if their value drops to a certain level. The selling of stocks that have dropped can be done either manually or automatically. For example, if you own company X's stocks and the value drops by 25%, you will consider selling the stocks and replacing them with another stock to prevent further damages to your overall portfolio; even though this selling can be done automatically as well by your broker. This strategy might cost you some profits down the road since stocks might rebound from their low levels, but by adopting a policy on how to protect your portfolio from major losses, you will also prevent further losses.
It is critical to leave emotions out of the equation when dealing with your investments and especially a company's stock that has lost its charm due to a major shift in its business. I always compare being invested in a bad company with being stuck in a bad relationship with someone. It might look tempting to stay in the relationship (which sometimes can be the solution depending on the context), but more often it is wisest to take the bullet, leave the unhealthy relationship (or in our case investment ) and keep building a healthier one in future.