Note: This is Part 1 of my 2-part Guide To Selling Stocks series. To see Part 2, click here.
Now You Own A Stock. When Do You Sell The Stock?
In theory, selling stocks is easy. The difficult part is putting the theory to work and actually selling stocks.
One of the most frequent questions our viewers ask me is:
When’s the best time to sell a stock?
I’m sure you have seen many stock market tips floating around on the internet and in articles telling you when to sell. The problem is, if you were to follow every tip you came across, you would walk away feeling very confused.
This is not a simple question to answer.
The Most Common Bad Advice On When To Sell A Stock (And Why It Can Drive You Crazy)
First, let’s take a look at some of the advice you may have come across:
“You’ll never go broke taking a profit”
I’m sure you have heard, “You’ll never go broke taking a profit”.
It seems like a reasonable piece of advice right?
However, if you were to sell all of your stocks as soon as they pass your buy price, you might just go broke after all. Trading costs will quickly eat up your profit.
“Buy the rumour; sell the fact”
Then there is advice to “buy the rumour; sell the fact.”
In other words, when you hear rumours of good news, you should buy and once the rumour becomes reality, sell the stock.
This idea is based upon the fact that generally, people overreact to rumours and therefore, the stock will be pushed further than what is justified by the news.
In some cases this can work in your favour, but this will only work if enough people “buy the rumour”.
“Sell in May and go away; don’t buy back ’til St. Leger Day”
The strangest advice I have heard is from the English phrase, ‘Sell in May and go away; don’t buy back ’til St. Leger day’.
To provide you with some background, the St. Leger Stakes, held in early September, is the final English ‘classic’ horse race of the flat season.
The idea behind this is that prices in London will drop during the summer months because the ‘City’ professionals head off to Wimbledon, Ascot, Henley and wherever else they go.
Therefore, it is said that you should stay away from selling during those months.
However, imagine if everyone sold their stocks in May. Then you would have to start selling in April and before that March and I’m sure you can see where I am going with this.
If you look at the other side of the coin, you would have the same situation when buying back in September and before that August and July…
I think you can now see how all of this advice can make your head spin. So, let me help you sort this out and show you what does work when it comes to the time to sell.
The Reality – Here’s ACTUALLY When To Buy And Sell
In reality, profits stem from holding undervalued investments and buying and selling is how we achieve those profits in the end.
We always want to make sure that you have a variety of undervalued investments.
By maintaining a balanced portfolio, we will minimize our risk should any one of our investments lose value.
Based upon what I just explained, here is when we should buy:
- It’s within our ‘circle of competence’ and we understand the business or stock well enough that we’re confident we’ve made the right choice. You will be amazed at how many invest with absolutely no idea and they did it based on tips given.
- Our purchase is below estimated intrinsic value, making our overall portfolio even more undervalued.
- The purchase allows further diversification and brings about a balance to our overall portfolio.
Now if we reverse the equation, we would sell a stock if:
- Our investment is no longer within our circle of competence and we have lost confidence in our ability to fully understand how this business will perform going forward.
- Our investment is no longer undervalued due to appreciation since we last purchased and it now adds overvaluation rather than undervaluation to our overall portfolio.
- Our investment now brings about an overexposure to one particular industry or sector and it may be time to lighten up to ensure balance is restored.
You Don’t Always Have To Trade And Hold Stock – Holding Cash And Not Doing Anything Is A Legitimate Position
So what should we do if it is time for a stock to be sold, but we can’t find anything to replace it with? We replace it with cash. You should measure a stock against cash, not another stock.
Cash can become an enticing option when the stock market becomes more expensive and opportunities are fewer. By holding more cash, you will most likely notice that your portfolio balance is improved. Conversely, cash may be less attractive when stock prices are lower and there are more opportunities to buy.
This may seem simple on the surface, but I caution you to avoid becoming overconfident in your assessment of value. Becoming overconfident can lead to making changes to your portfolio too frequently.
As I mentioned earlier, it is easy to become caught up in rumours and media hype and if you do, reasons for buying and selling will appear everywhere you look.
Most of us are likely to choose activity over inactivity.
Consequently, if every time you thought it may be a good idea to trade a stock you held, you might as well let your broker take over your portfolio and walk away.
The Car Analogy – What Happens When You Make Changes To Your Portfolio Too Frequently
Think of it in terms of driving a car.
You are in traffic and rather than patiently waiting, you keep changing lanes to get away from the car in front of you and move faster.
While it may make you feel better in the immediate sense, you are probably just burning more fuel and in the end, not getting any further than had you stayed in one lane and it is costing you more.
If you are the type of investor that is a constant lane-changer, it may be time to lightly step on those brakes and slow down. One way of doing this is to add to your portfolio only if you are very confident that it will improve your portfolio. This will provide you with a margin of safety when you do make that purchase.
By doing this, you will have the flexibility to give the stocks in your portfolio the benefit of the doubt. However, there may be instances where you may need to do the opposite and ask the stocks to justify themselves once again.
In the future, I’m gonna show you ways in which this theory can be applied in practical situations.