Do you feel comfortable with the basics of investing in stocks but feel less comfortable knowing when to sell stocks? Knowing when to exit a stock can give you greater profits, a more diversified portfolio and limit your losses when times are tough.
We've put together a comprehensive list of reasons for selling part of your portfolio as well as a guide for how to know when to sell a stock.
Understanding When to Sell or Hold an Investment
When making investment decisions, portfolio managers and individual investors must constantly ask themselves when to buy and sell stocks. Many factors go into this decision, but one of the most important has to do with your expected return from your investment.
If the expected return is greater than the return you could earn by investing in a different security or asset class, then logically, you should hold the investment. However, if the expected return is less than the return you could earn by investing elsewhere, then the decision to sell is warranted.
Reasons to Sell a Stock
Let's take a look at some reasons you might consider selling a stock.
Reason 1: When the company is about to be acquired.
If a company (of which you own stock) announces that another company will acquire it, it may be a good idea to sell your shares. The stock price of the company will likely rise to the agreed-upon purchase price, so you may not see much more upside potential.
You may also not be happy with the direction the company is going after the acquisition and you want to sell your shares before the company changes. Finally, you may simply want to cash in on your investment.
Reason 2: When you need to reduce your opportunity cost.
When do you sell your stock in a company? You might want to take advantage of a better investment in the market.
For example, let's say you have $1,000 in Company XYZ stock but you learn about investing $1,000 in Company ABC stock through what CEOs are currently buying. ABC is a newer company with a lot of potential, and you believe it will do well. In this case, selling your XYZ stock to invest in ABC stock makes sense because you'll trade a lower-returning investment for a higher-returning one.
Reason 3: When you need to diversify your portfolio.
There are many reasons you may decide when to sell shares, but one of the most common is to diversify your portfolio. Selling stock adds new asset classes and reduces your overall risk.
Diversification allows you to spread risk across different asset classes. This way, if one investment loses value, the others may offset the loss. For example, if you invest only in growth stocks and the stock market crashes, your entire portfolio will lose value. However, if you diversify your portfolio by adding more defensive investments, your portfolio will be less likely to lose all of its value.
One way you may consider diversifying your portfolio involves buying stocks that company executives buy up. See our guide on insider buying information for investors for more information.
Reason 4: When the company is in a declining industry.
When an industry declines, it means that you may find less demand for the products or services that the industry produces. This can occur for a variety of reasons, such as changes in technology or changes in consumer preferences. When an industry is in decline, you may want to sell a stock.
Look at the reasons for the decline and whether or not the company can still be profitable. If the company cannot be profitable, you may want to sell it. If the company is still profitable, it may be worth holding onto the stock in case the industry recovers.
Reason 5: When the company is in financial trouble.
There are a number of reasons why you might want to sell a stock in financial trouble. First, if the company is in danger of bankruptcy, you could lose all of your investment. Second, even if the company isn't in danger of bankruptcy, it could still face serious financial problems that could lead to a decline in stock value.
Finally, if the company is under investigation by regulators or is embroiled in legal troubles, the value of the stock could drop sharply.
How can you stop this happening to you? Consider what CFOs are buying and selling; they are some of the most educated investors in the market.
When to Sell Stocks for Profit
Let's take a look at some reasons why you should sell stocks for a profit, including when the stock rises, when it is overvalued and when the fundamentals change.
When the Stock Rises
As a general rule of thumb, you may want to sell when the stock price goes significantly higher than the original purchase price. This allows investors to lock in their profits and avoid the risk of the stock price dropping in the future. Don't forget to consider the tax implications of selling stock, as this can impact the overall profitability of the transaction.
Once a stock price rises above the purchase price, it becomes a profit-taking opportunity. If you continue to hold the stock, you risk the chance of the stock price falling back below your purchase price, which would result in a loss. Selling the stock once it rises above your purchase price allows you to lock in your profits and avoid any potential losses.
When the Stock is Overvalued
When a company's stock price is higher than its intrinsic value, it's considered "overvalued." Investors may buy overvalued stocks for a number of reasons, including the hope that the stock price will continue to increase or that the company will be acquired. However, eventually the stock price will fall back in line with the company's intrinsic value.
When this happens, investors who continue to hold the stock may experience significant losses. There are a number of reasons why investors may choose to sell an overvalued stock, including to lock in profits or to avoid potential losses. While there may be some upside potential if the stock price continues to increase, the downside risk is typically greater.
When the Company’s Fundamentals Have Changed
If a company's fundamentals have changed, it may be time to sell the stock. The company may have new management, a new business model or new products that don't fit with your investment strategy.
The company may also have once been profitable but may now be in danger of bankruptcy or quickly losing ground to competitors. You can also see information about insider selling to discover whether your stocks are being sold off by heads of management. These are all valid reasons for you to consider selling a stock.
When to Sell Stocks at a Loss
When should you sell stocks at a loss? Let's take a look at some reasons to consider selling stocks at a loss.
When You Need the Money
Selling stocks allows you to access the money you've invested without having to sell other assets or take on debt. This can be especially helpful if you need the money for an emergency expense or other unexpected event.
Second, selling stocks may help you avoid taxes on your investment gains. If you sell stocks that you've held for less than a year, you'll generally pay short-term capital gains taxes on your profits. However, if you sell stocks that you've held for more than a year, you may be eligible for long-term capital gains rates, which are typically lower than short-term capital gains rates.
When You Want to Cut Your Losses
One reason to sell involves limiting the amount of money you lose. If you wait too long to sell, you could end up losing a lot of money. Selling as soon as you start to see a loss can minimize your losses.
You may also want to free up cash. If you keep your stocks, you may not have as much cash available to invest in other things. Selling stocks gives you more cash available to invest elsewhere which can help you reach your financial goals faster.
When You Are Close to Retirement
Perhaps you need to generate some extra income to supplement your retirement savings or are concerned about the potential for market volatility in the years ahead.
Stock prices can take years to bounce back. If your horizon is short, you may not have enough time to see the price returned in order to sell it for a profit. Selling stocks, even at a small loss, may be worthwhile.
When the Company Announces Poor Financial Results
Selling a stock when a company announces poor financial results can make sense. Even if the company is not in danger of bankruptcy, poor financial results can signal that the company is not doing well and that its stock price is likely to go down. By selling the stock, you can avoid losing more money.
One common side effect of a company posting poor results is that it may attract the interest of short sellers. The degree of enthusiasm by this crowd may be measured by the short interest ratio. Poor financial performance is a good explanation for shorting stocks.
If a company continually posts lower revenue and earnings numbers and there is a clear trend heading toward the bottom, exiting from a potentially disastrous situation may save you headaches and money later on.
When Not to Sell a Stock
For most people, having a long-term outlook attitude on holding stocks will yield the best results. This means it's generally inadvisable to sell a stock just because its price moves up or down — it should be held long-term (one year or longer) to realize the most gains.
How to Decide Which Shares to Sell
Thinking about selling part of your stock portfolio? Here are some steps to follow to determine which stocks to sell.
Step 1: Consider your investment goals and financial needs.
First, assess your investment goals and overall financial health and let it guide your decision as to which shares to sell. For example, if you need to free up cash urgently, then it matters less which shares you sell. If you want to maximize profits, then you can be more selective.
Step 2: Review your portfolio.
To get cash in hand quickly, review your portfolio for stocks that have high liquidity (are frequently traded) and will give you at least a break-even profit if you sell them. Sell shares that have increased the most since you bought them.
Step 3: Sell your shares.
Sell your shares through a broker. Remember to factor in platform fees and any commissions or other costs when calculating your net profit from the sale.
Know When to Sell a Stock for Profit or Loss
It's important to know when to buy and sell stocks. Sometimes selling a stock can be a good idea that will lead to greater gains down the road. Other times, you should do it to prevent further losses and protect your capital. In either case, there are many worthwhile reasons for doing so.