Newsletter
stock trading - buying selling stocks on laptop

7 Signs You Should Drop That Stock

by -

We all like to buy – it feels good – and many investors spend a lot of time carefully analyzing stocks looking for the perfect investment. But what about selling? It rarely feels as good.

When a stock performs badly, we instinctively want to hold on and wait to see if the situation improves: we don’t want to feel like we’ve “lost.” Yet, when a stock does rise, our first instinct is to lock-in a profit by selling the stock – potentially losing out on further gains.

These emotionally-driven sales are why most investors tend to sell stocks at the wrong time.

What Is The Right Time to Sell Shares?

When you purchase a stock, your intention should be to hold onto it forever (if it continues to perform well). With a few exceptions, the only time you should sell a stock is if it no longer meets your criteria for a good investment.

For example, a stock rises higher and quicker than your estimations, should you sell? It depends – is it still a good investment? If it’s long-term prospects are good you should hold on; selling to grab a certain profit might feel good, but if you’d have gained more by holding it’s a losing move.

What about if a stock loses value? You must resist the temptation to sell and assess the stock’s potential. If it’s still a strong investment, a dip in price is an opportunity to buy – at the least, you should hold on to your current investment. Always trust your judgment, not your emotions.

When to Sell Stocks – The 7 Signs Its Time to Sell

There are several obvious signs when it’s time to sell an investment. In many cases, just one of these signs should be enough for you to hit the sell button:

Sign 1: The Stock Is No Longer Undervalued

One of the key strategies behind value investing is to find stocks that are undervalued by the market. When this no longer holds true, it is time to sell. This change in value might happen quickly, or over a long period.

For example, stock XYZ rapidly increases in price in anticipation of an important announcement. In this scenario, it is common for the market to overcorrect and overvalue the stock; when the announcement comes, the share price then drops again. When a stock’s price rapidly increases you should check that it is still a good investment.

Netflix app on Laptop screen
Netflix stock spent most of 2016 in the $100 area but have since passed the $300 mark (April, 2018).

In another example, stock XYZ’s price-earnings ratio steadily increases over time until it is significantly higher than what you’d expect from that industry. This is a sign the stock may be overpriced. Regularly check your investments for warning signs of overvalue, and don’t be afraid to hit the trigger.

Sign 2: If The Long-Term Prospects of The Stock Have Diminished

Changes in sales, debt, and cash-flow can all signal a reduction in the long-term prospects of a stock. Other warning signs include new competitors, a change in competitor strategy, or new legislation that may change the outlook for that industry.

For example, a new import tax of 20% on key imports for a company may significantly reduce its future profitability, and you should reassess whether it is still a worthwhile investment.

Sign 3: Leadership Changes

A change in leadership can significantly alter the long-term prospects of the stock. A new leadership style, strategy, and vision can bring new life to a company; but it may also damage it. If the previous CEO was a key reason behind your decision to invest, it is time to rethink your investment.

Sign 4: You Don’t Understand The Stock

There should be little room for guesswork in your investment strategy; if you cannot understand a stock, it may be time to sell. For example, a business you invest in starts investing heavily in a new technology. If you don’t understand that technology, the market for it, and why it may be beneficial you will struggle to assess the long-term prospects of the company.

Sign 5: You Can Expect a Higher Return By Trading Into Another Asset

It is correct to sell a good investment when the money can be invested in another asset where you can expect to receive a higher return. When calculating whether this is a good idea you must remember to take capital gains tax into account. Additionally, you should consider how changing from one stock to another will affect your overall risk profile.

Sign 6: Changes In The Stock Cause Your Portfolio To Become Unbalanced

Can a stock be so successful that you want to sell it? Sometimes – it depends upon your attitude to risk. For example, you bought stock XYZ five years ago, and it’s been a big success, rising to a share price that is 8x higher than when you first invested. It now makes up 25% of your portfolio – and you prefer not to have any stock making up more than 15%.

In another scenario, several successful investments and a booming economy have left your portfolio weighted heavily towards cyclical stocks. You would like to re-balance so that you have a more equal split between cyclical and defensive stocks.

In both these cases, selling some stock and reinvesting in other opportunities can reduce your risk (and your stress levels).

Sign 7:  You Need The Money For Something Else

The primary reason we invest in stocks is to provide a steady and safe future for ourselves and our families. In some cases, you may need to sell good stocks to fulfill this objective. For example, you might need to buy a new house, invest in a new car, or cover other unforeseen expenses such as medical bills.

When to Sell Stocks At a Loss – and When To Hold On

Selling stock for less than you bought it for never feels great, but if you maintain a rigorous decision-making process, it shouldn’t be a mistake. If new information indicates a stock is overvalued, or its long-term prospects have diminished considerably, selling that stock is the correct decision. If you hold on to that stock for longer, you will probably lose more.

Sometimes, selling a stock immediately at a loss is the most profitable decision you can make.

Note: The opinions expressed in this article are the author's own and do not necessarily reflect the view of Alvexo on the matter.