When Should You Sell a Stock?
We all want to buy stocks that continue to rise for years, and some do, but sometimes it’s time to ring the register and take our profits on a stock that may be ready to stop rising or potentially reverse and head back down.
How to Know When to Sell a Stock
How do you know when it might be time to sell a stock that you’ve already profited from? Here’s an example:
Let’s say you found a great stock at $30.00 and through fundamental analysis—which is basically taking all of the economic information possible about a company to arrive at a fair value, or fundamental price target—you determined that the fair valuation of this stock should be $50.00. $50.00 is obviously higher than the stock’s market price of $30.00, and so you decide to buy it.
Over the course of the year, the price slowly rises up to $50.00, which meets your target. Then you again used fundamental analysis and come to the conclusion that the fundamentals now do not justify raising the price target beyond $50.00. For that reason, you should sell your stock and take the profits.
Quick and dirty tip: In short, if a stock you bought rises to your fundamental analysis price target, take a few moments to see if analysts or your research suggest raising the price target further, and if not, sell your stock immediately as it has hit your profit target.
Other Ways to Know When to Sell a Stock
By the same token, a price might hit your technical or chart target. If you look at a monthly chart of a stock and find that the price peaked at a resistance level years ago and you decide that you think the stock will return over time to that resistance level, you might want to sell if the stock does rise to the resistance level you thought it might.
For example: Let’s say a stock was $50.00 in 2007 at the market peak and the stock fell in 2009 to $30.00, where you determined it was a strong fundamentally sound company with a price chart that is rising. Let’s say the bottom price was $20.00 and it has been rising higher from there with a positive trend.
If in 2010 the price has returned to the recent high of $50.00 per share, which was your chart target, then you should sell the stock if you feel this is a resistance level that buyers will be unable to push through, or the fundamentals have gotten worse over the last year.
These two methods can be summed up as “Sell when price hits a fundamental valuation price target, or prior resistance chart target.”
Easy enough, right? Exiting with a profit when the stock did what it was supposed to?
What About When Your Stock Hasn’t Met Its Target?
But what happens when things change but your stock has not risen all the way either to your fundamental or chart target?
We’ve mentioned the 200 day simple moving average, especially on a daily chart of a stock, to be a very important line that many investors watch very closely.
You should buy fundamentally sound stocks that are above their 200 day simple moving average on a stock chart. But what happens when you buy a stock and over time it rises, but then starts to fall?
You know you can’t exit at the absolute peak, so you have to make some compromises. One of those compromises is to sell when a stock falls under its 200 day simple moving average. Think of how much money this might have saved investors if they followed this rule early in 2008.
An Example of Using the Moving Average
A few examples of this show us that Google (GOOG) broke under its 200 day moving average in January 2008 at $565 per share. Google peaked at $740 per share in November 2007.
I know– you’re thinking that $175 is a long way to hold a stock from its peak to where you sold it, but consider if you decided to hold on to Google and did not sell when it broke under the 200 moving average.
Google fell all the way down to $250 per share in October 2008 and you would still be holding the stock. Yikes!
Think of the 200 day moving average as a last chance sell if you’re still holding on to a stock and haven’t sold yet. It will never get you out at the high–nothing will–but it will save you from holding stock through a nasty bear market should one develop in the future.
Use the Fundamentals to Decide When to Sell a Stock
Now let’s go back to the fundamentals. If you bought a stock based on great cash flow, low cash to debt ratios, a great PE ratio or other fundamental values, be sure to keep checking these same values at least once a quarter when new earnings reports come out.
That is a lot more work than seeing if price breaks under a 200 day moving average, but it can get you out sooner. If the fundamentals start deteriorating in a stock, go ahead and sell it and buy a stock with better fundamentals.
Use a Fixed Percentage Loss to Know When to Sell a Stock
Finally, you can use a fixed percentage loss, what we would call a stop-loss, to take you out of a position that didn’t go as expected.
A good rule of thumb is to take the price off the stock when you bought it, figure out what 8% to 10% of that price is, and then subtract that value from the original price you bought it for. You’d sell when price falls to that level after you bought it.
For example: Let’s say you bought a stock at $50.00. 10% of $50.00 is $5.00, so if the price ever falls to $45.00 in the next few months, you will sell the stock, no questions asked. That will protect you from losing money if the stock keeps falling to $40.00 or less, no matter what the fundamentals or the charts say about the stock.
You can actually trail this value higher as the stock makes money for you in your portfolio, and adjust your stop by moving it higher over time. We call these trailing stops. That will allow you to lock in profit after the stock has peaked and started heading lower.
Below is just a little information on this topic from my small unique book “The small stock trader”:
The most significant non-company-specific factor affecting stock price is the market sentiment, while the most significant company-specific factor is the earning power of the company.
Perhaps it would be safe to say that technical analysis is more related to psychology/emotions, while fundamental analysis is more related to reason – that is why it is said that fundamental analysis tells you what to trade and technical analysis tells you when to trade. Thus, many stock traders use technical analysis as a timing tool for their entry and exit points.
Technical analysis is more suitable for short-term trading and works best with large caps, for stock prices of large caps are more correlated with the general market, while small caps are more affected by company-specific news and speculation…:
Perhaps small stock traders should not waste a lot of time on fundamental analysis; avoid overanalyzing the financial position, market position, and management of the focus companies. It is difficult to make wise trading decisions based only on fundamental analysis (company-specific news accounts for only about 25 percent of stock price fluctuations). There are only a few important figures and ratios to look at, such as:
• Pr oducts
• Dividend yield
Furthermore, single ratios and figures do not tell much, so it is wise to use a few ratios and figures in combination. You should look at their trends and also compare them with the company’s main competitors and the industry average.
Preferably, you want to see trend improvements in these above-mentioned figures and ratios, or at least some stability when the times are tough.
Despite all the exotic names found in technical analysis, simply put, it is the study of supply and demand for the stock, in order to predict and follow the trend. Many stock traders claim stock price just represents the current supply and demand for that stock and moves to the greater side of the forces of supply and demand.
If you focus on a few simple small caps, perhaps you should just use the basic principles of technical analysis, such as:
• Price and volume
• Support and resistance
• Trends and moving averages
I have no doubt that there are different ways to make money in the stock market. Some may succeed purely on the basis of technical analysis, some purely due to fundamental analysis, and others from a combination of these two like most of the great stock traders have done (Jesse Livermore, Bernard Baruch, Gerald Loeb, Nicolas Darvas, William O’Neil, and Steven Cohen). It is just a matter of finding out what best fits your personality.
I hope the above little information from my small unique book was a little helpful!