It’s easy to buy a stock. You can listen to a hot tip, do some research, be persuaded by a broker or even throw a dart at the stock tables in the newspaper. But how do you know when to sell?
Selling a stock is much harder because you never hear a tip at a cocktail party or from your neighbor to sell a stock. And high-priced Wall Street analysts rarely issue sell recommendations. In fact, Credit Suisse currently has only 19% of the stocks they cover rated “Sell,” so you shouldn’t rely on analysts for timely advice on when to sell.
If a stock is down, it’s hard to accept and acknowledge that the money is lost. And if a stock is up, will it go higher?
Here are some rules for determining when to sell.
Can you give a simple, reasonable explanation of what each company that you own stock in does? You don’t have to know the quarter to quarter earnings comparisons or the current status of their debt, but you should understand what a company does to earn its profits. If not, sell. I can explain quite easily what products Procter and Gamble sells to earn money. On the other hand, there is CytRx. Even though I can explain that they are a biotechnology company, I still don’t have any idea of what they actually do.
Don’t get emotionally attached. Hope and prayer will not make a stock go up. Is a stock down because of overall market action? Or headlines in the news that will in the long run have minimal impact? There have often been sell-offs of drug company stocks because one drug in their pipeline didn’t pan out. One drug is not going to make or break Pfizer or Merck.
Is the stock down because of fraud or criminal activity on the part of the management, like Nortel or Fannie Mae? If so, then sell.
Be wary of a sudden shift in gears. A company that is struggling may only falter further when it invests in areas outside its expertise. A business in one industry the buys a company in another should be analyzed with extra scrutiny. Are these two business lines compatible and does the acquiring company have the expertise to integrate the acquisition? One example would be Time Warner buying AOL in 2001 and now planning a spin-off to rid itself of the business. Clearly, shifting from one business to another could be cause for concern.
Don’t sell the winners. People tend to sell their winners and hold on to the losers. In my portfolio, I’ve held most positions for years. If the company continues to increase in value, I want to continue to reap those benefits. Also, if I sell a company I know a lot about, I have to find a replacement that I can comfortably admit I know as well or better.
Some stick to a rule such as “double and out,” or when a stock doubles, sell it. I don’t agree. If your comfort level dictates that you would like to lighten the size of your position, but you still want to own the stock, sell enough to equal the amount of your original investment.