5 Signs You Should Sell a Stock
Dear Rich Lifer,
In 1929, JFK’s father Joseph Kennedy Sr. scored a massive windfall by timing the market crash.
Like most other investors, Kennedy Sr. had already made a decent amount of money buying stocks and watching them climb during the 1920s bull market.
But it wasn’t until he received some unsolicited advice from a shoeshine boy that made him realize it was time to sell.
While sitting in the shoeshine chair, Kennedy Sr. couldn’t believe his ears. The shoeshine boy, no less, was giving him tips on which stocks to buy.
That experience resulted in a life-changing moment for Kennedy Sr. who quickly went back to his office and started unloading his entire stock portfolio.
He didn’t just get out of the market, he aggressively shorted it too — and as a result, got filthy rich following Black Tuesday.
Why Timing the Market Is So Hard
Most investors will never be able to do what Kennedy Sr. did by timing the market in this fashion. Either they’ll get too greedy and hang on too long, watching their profits retract.
Or they’ll panic and sell too early, realizing only a fraction of the profits they could have gained.
You could argue a profit or loss is made the moment you buy a stock. But buying at the right price is only half the battle. You also have to know when to sell to guarantee your profits.
Today we’re going to share five strategies you can use to know when to sell. Once you know the signs, you’ll have no problem exiting your position.
- Hit Your Price Target
Good investors establish a price target, or range when they will sell a stock. Every stock purchase should include some analysis about what the stock is worth, its current price, and how much the stock is discounted for.
For example, if you value stock at say $30 and the price to buy is $15, then selling when the price doubles is a good price target. You’re essentially saying you believe the stock is undervalued by 50%.
While coming up with a single price target can prove challenging, it’s often easier to settle on a price range and decide if the stock price falls within your target range, then you’ll sell.
- Fundamental Decline
On top of tracking a company’s stock price after you establish a price target, you also need to pay close attention to the performance of the underlying business.
Another good time to sell is when the business fundamentals start falling apart. Good investors will notice a decline in sales, profit margins, cash flow, and other key operating fundamentals before the stock price starts to erode.
You might even want to dig deep into the financial statements and read all the footnotes that other investors are likely to miss.
A common and serious fundamental flaw is fraud. Investors who were early to the party and able to spot financial fraud in businesses like Enron and Tyco were able to save large sums of money exiting their positions before these firms collapsed.
- Trade Up
Before you buy any stock, always compare it with the potential gains you could earn owning another stock. If the alternative is better and you’re already invested in the other stock, then it makes sense to exit your current position and buy the other.
Being able to identify opportunity cost is not easy. Sometimes investing in stock within the same sector or market segment makes calculating your opportunity cost easier. The point is don’t be afraid to trade up if a better opportunity presents itself.
- Following Merger
On average takeover premiums, or the price at which a company is bought out, generally ranges between 20-40%.
If you’re lucky and own some stock that ends up being acquired for a significant premium, your best bet is to sell soon after. In some cases, it’ll make sense to hang on to your position, especially if the combined companies create some strong competitive advantage.
But, most mergers have a bad track record of being successful. And, they can take several months to complete. So, from an opportunity cost perspective, it’s not always worth it to wait for a better price. You might as well cash out now and find your next investment opportunity.
- Following Bankruptcy
This last one should be obvious, especially since most bankrupt companies are worthless to shareholders. But for tax purposes, it’s important you sell or realize the loss so you can offset any future capital gains.
By selling a stock soon after a bankruptcy, you’ll realize a large loss, but you may still be able to salvage some cents on the dollar. Don’t wait thinking things could turn around. Cut your losses and move on.
There are no absolutes when it comes to knowing when to sell stock. However, if you take the following strategies into consideration when you invest, you’ll begin to remove some of the emotions clouding your better judgment and holding back your profits.
To a Richer Life,
The Rich Life Roadmap Team