When Should You Sell a Stock?
Investments 101
9.11.2024 1:03 AM
When it comes to investing, deciding when to sell a stock can be more challenging than deciding when to buy one. Is the best time to sell when a stock drops significantly to avoid further losses? Or is it better to sell when it rises significantly to secure profits?
Ultimately, these two reasons ignore the fact that the stock market doesn't really care how much you paid for a stock. In this article from Hapi, we’ll explain four reasons you should consider selling a stock in the U.S. stock market.
In this section, we assume that you bought a stock after thoroughly analyzing the company and at a reasonable price. This means that the company you invested in had attractive characteristics, such as clear financial strength, and was sold below its intrinsic value.
If the initial investment wasn't made with a comprehensive prior analysis, the contents of this article may not be the most appropriate to consider when deciding to sell. Investment mistakes happen, and the sooner you realize it, the better. With that in mind, here are the four main reasons to sell a stock:
Businesses are constantly evolving, and the future doesn't always align with our expectations. If the main reason you bought a stock no longer holds, you may want to consider selling.
This could happen due to internal factors such as discontinuing a major project, issuing new shares that dilute investors, or a significant change in management. If the company consistently fails to meet its projected sales or earnings, it might be time to move on.
You may also consider selling due to a risky investment decision, like when Meta, formerly Facebook, shifted its focus entirely to the development of the metaverse. Some saw this as the right direction, while others opted to sell since it no longer aligned with their initial investment thesis.
All of these unexpected events add uncertainty to the company's ability to generate profits in the future, which could negatively affect your investments.
Similarly, external factors can also prompt a sale. These may include significant regulatory changes, new competition, or a challenging macroeconomic environment.
A clear example is how COVID-19 impacted tourism companies. Many didn't have the financial strength to weather the shutdowns and had to take on excessive debt or dilute shareholders through stock issuance. To avoid this, make sure the liquidity ratios are in good shape before investing.
However, don’t confuse these factors with alarming headlines that have little long-term impact. To determine which news is relevant to your investments, it's important to analyze how these events will impact revenue, margins, cash flow, and dividends each quarter.
This is one of the easiest reasons to identify if you bought the stock below its intrinsic value. You can sell when the stock reaches the value you estimated as its fundamental worth.
Often, markets can become overly optimistic about a company's future results, pushing its stock price to unsustainable levels. When a stock price reaches a level that even the best profit estimates can't support, it might be a good time to sell.
This strategy assumes you bought the stock undervalued and are selling it at a fair or overvalued price. As the stock price rises above its intrinsic value, it becomes riskier because it's likely to fall back to reasonable levels.
This reason ties into the concept of opportunity cost, the foundation of economic analysis. If a better investment opportunity with higher potential returns emerges, it makes sense to shift your money from one stock to another. Buying and selling stocks is essentially a constant assessment of opportunity cost.
If you want to be a successful investor, you need to be opportunistic. The goal is to get the highest possible return with the lowest risk. If holding onto a stock isn’t as attractive as investing in another, selling may be the right move.
While it’s always ideal to have cash reserves ready for great opportunities, there may be times when you want to invest more than what you have on hand.
Many investors choose to diversify their portfolios across different types of stocks or even other assets like commodities and ETFs. They allocate a specific percentage of their portfolio to each investment category. One example is Ray Dalio’s All Weather Portfolio, which adjusts to different inflation and economic growth scenarios.
If one position performs very well and becomes too large due to a price increase, you could sell enough to return to the original balance and use that money to buy more of the positions that have decreased in value. This helps maintain your initial asset allocation. You’ll also likely be selling an overvalued stock and buying one that’s undervalued.
However, be cautious about rebalancing too frequently, as it could cause you to sell great companies and invest in others with uncertain futures.
For short- or medium-term investors familiar with charts, technical analysis can help determine the best time to sell and maximize returns.
For example, the Relative Strength Index (RSI) provides signals on bullish and bearish momentum. A stock is generally considered overbought when the RSI is above 70 and oversold when it’s below 30. Other popular technical indicators include moving averages, MACD, and Fibonacci levels.
A short-term price change alone shouldn’t be enough to justify selling a stock.
Just because a stock’s price has risen doesn’t mean you should automatically sell. Winning stocks tend to rise for a reason and often continue to perform well over the long term. On the other hand, simply selling because a stock’s price drops could be a mistake. Every investor wants to buy low and sell high—selling a stock just because it dropped is the opposite of that.
As mentioned earlier, justified reasons for selling include significant changes in the company’s fundamentals, a stock reaching or exceeding its intrinsic value, a better investment opportunity arising, or needing to rebalance your portfolio. Whatever the reason, it’s important to make informed decisions and always trade on secure platforms.
Hapi is an app for investing in stocks securely and easily, where you can trade commission-free from Latin America. Stay informed about market movements and how to improve your personal finances through their blog and social media. If you want to open an account, just follow this link and do it in minutes!
Finally, remember that these are not investment recommendations, and there are no guaranteed returns in the U.S. stock market.
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