When to sell stocks

When to sell a stock

Having bought stocks, the problem is to decide on when to sell them.

Before you proceed further, ponder on this - What is YOUR selling strategy? Do you have one? Have you thought through and come to your own conclusions about which of the very many varied approaches to selling make sense?

I am a big believer that making spur of the moment choices about selling, or for that matter buying, is suboptimal. In the long run it might prove injurious to your financial health. To me, it makes sense to have a structured approach to buying and selling. There are a lot of strategies out there - try to pick one that makes most sense to you.

My take on on what others are saying about it (When to sell stock) …
Sell when:
1. You need money (ie. personal reasons - which hardly merit any further discussion)
2. When the stock rises above your desired price (ie. book profits )
3. When the stock falls below your threshold price (ie. stop loss triggered)
4. When new information causes change in your investment hypothesis (ie. you made a mistake)

The logic, approach and the reasoning might be different, but in essence, almost everyone seems to agree with the above. The above seems to hold good irrespective of the type of investor or trader (short/medium/long/whatever term, day/swing/positional/whatever ) one decides to call oneself.

Duh! Wasn’t selling a stock supposed to be more complicated? Then why is there so much source of confusion? What is missing in the above summary?

Well two things …

First, the implied desire behind the quest of “when to sell” question is not understood.
Second, the methods and manner of arriving at the “desired price” and “threshold price” are not explored properly.

The quest behind when to sell …

Let us say I have the perfect answer to “when to sell ABC stock” … what would your expectation be ? Wouldn’t it be that I should be able to guide you in selling the stock at the absolute high (or something close to it)? The stock should fall soon after you sell it and should not increase substantially beyond your selling price .

There in a nutshell is the problem. When we are looking for a strategy to sell what we are actually looking for goes something like this:

Tell me how can I sell at or close to the very top? Hey, while you are at it, keep in mind two things …

1. I should be spared the pain of being wrong about the stock after I am right (after having made paper profits, I don’t sell and the stock drops like a ton of bricks to way below my price. ouch! ).
2. I should equally be spared the pain of being very right about the stock (the stock skyrockets after I sell, ouch! ouch!).

In short, tell me how can I squeeze the last little profit from the market, outsmart it and be spared of every kind of pain.

Do you see the problem here? Now can you see where part of the confusion is coming from?

You can solve the first part of the problem by simply acknowledging the fact that the market will make a duffer out of you sooner or later (and often). Irrespective of how you choose to buy and sell stocks:

1. There will be some stocks that will become multibagger after you sell your lot.
2. There will be some stocks that fall below your purchase price after showing handsome paper profits.

Like death and taxes, this is INEVITABLE.

Once you understand that there is NO WAY to always outsmart the market, you can look to develop a rational selling strategy that YOU feel comfortable with.

Determining the price at which to sell the stock

I think its a mistake to consider the selling strategy in vacuum. It should go hand in hand with your buying strategy (nay. you should take into account your whole portfolio policy). Your buying should support your sell rule and your selling should be in sync with how you buy stocks.

If you are investing (as opposed to trading), you should clearly have a minimum profit potential built into your buying rule. The buying rule should include sufficient margin of safety. You should be convinced at the point of buying the stock that it offers adequate safety and desired profit potential.

Here again there are two approaches - margin of safety and intrinsic value.

With margin of safety, you are not doing valuation of individual businesses. You are just trying to ensure that the business representing the stock is worth a lot more than what the market is offering it for. You don’t necessarily have to know about the management, its products, its revenue model, capex plans or anything complicated. The classic Graham way is to look at the company as a black box and measure the box by just looking at its output.

With intrinsic value approach, you buy stocks (businesses) that you understand well and can realiably arrive at its intrinsic value. Here you are doing business valuation. You do a deep dive and look at and into the company in great detail. You care not just about the output, but also what is inside the box. Actually, you rip up the box. This might mean, among others, looking at the management, their performance, the competitors, the buyers, the suppliers, the upstream/downstream value integration, competitive advantage, period of competitive advantage and what not. After analysing all the different factors, you come up with your own conservative “intrinsic value” of the company - one with adequate margin of safety. When the market offers you the stock (company) at a huge discount to your evaluated “intrinsic value”, you lap it up with glee. You periodically monitor the company to check if its intrinsic value has increased or decreased.

Either way you begin with target profit potential in mind. You are not interested in buying a stock unless at the current price is value enough to generate the required upside.

In the first case you sell when it reaches your target price and in the second case you sell when the price is close to the intrinsic value.

To Stop Loss or Not

Having loss in some stocks of your portfolio is almost a mathematical certainity. It is not something to worry about - but certainly something to anticipate and plan ahead. You should know before hand what YOUR default action will be if the price of the stock keeps dropping.

Stop loss is an issue on which different people have very strong and diametrically opposite views.

Essentially there are three approaches:

1. Sell when the stock falls below threshold price (saying yes stop loss)
2. Buy more when the stock falls (averaging down)
3. Do nothing (no stop loss, but no averaging down either)

I have thought long and hard about this and am convinced all three approaches make sense. I can make a case for each of the above approaches.

If you are a trader you DEFINITELY need stop loss. If you are an investor, pick any one of the approaches that makes most sense to you. If you decide to go with the stop loss, it essentially involves picking an arbitrary number (say X) and consistently selling any stock that falls by X percent. Some practising investors have suggested that one should stop loss at 25% (Anthony Gallea in the book Contrarian Investing). I have nothing intelligent to add to this.

If you make a mistake …

If new information, data or analysis reveals that your investment was a mistake, just sell and come out. You don’t argue with your mistakes - just acknowledge them and rectify it. In the intrinsic value approach, you still don’t sell the stock in a loss unless you are quite sure that the price offered by the market is more than your evaluated intrinsic value.