In some cases, the decision to sell a stock or stocks may be precipitated by a combination of intrinsic and extrinsic factors. For example, let’s say you lose your job because of a corporate restructuring and are a few years from retirement. You have been uneasy about the markets’ elevated levels and historically high valuations, but you previously felt little inclination to act upon it. Now, however, you would like to conserve your capital with the intention of using it in the business that you always dreamed of starting. In this case, your sell decision is justified by intrinsic reasons (your lifestyle change) as well as extrinsic ones (markets’ elevated levels /valuations).
Category: When can we sell stocks
Extrinsic Reasons to Sell
Financial reasons: This can include any number of reasons pertaining to the investor’s finances. For instance, a stock may have gained so much in proportion to the rest of the portfolio (as in the example of the biotech stock mentioned earlier) that the investor may need to rebalance it to bring it back in balance. Or the investor might wish to sell a stock to book a loss for tax purposes. Another reason to sell a stock could be because the investor needs cash to deploy in a competing investment, such as real estate. Such financial reasons are pretty potent ones to justify selling a stock.
Lifestyle reasons: Lifestyle changes also present good reasons for selling a stock. Younger investors might consider selling all or part of their portfolio to make a down payment on a house or buy a car. Investors nearing retirement might sell stocks to wind down the equity part of their portfolios and reduce their risk exposure. Parents may also sell stocks in tax-advantaged plans earmarked for specific purposes such as their children’s education.
Intrinsic Reasons to Sell
When the initial buying decision was a mistake: Most experienced investors may have encountered this situation at some point. You’ve watched this stock—or more likely, a meme stock—make phenomenal gains on a daily basis, so you finally decide to suspend your disbelief and recklessly put in a sizable buy order for the stock. But as soon as you do so, you realize that you’ve probably made a mistake. The best course of action in this case is to sell the stock, even if it means taking a small loss on the trade. And to avoid making the same mistake in the future, resist the temptation to chase hot stocks that are running on fumes, as they may burn you financially.
When the price rises dramatically: Selling a stock merely because it has risen dramatically in price isn’t always the best course of action. In some cases, the price gains may be justified by the company’s underlying fundamentals (for example, its sales and/or earnings may be growing faster than investors’ expectations). But in other cases, the price may have posted exponential gains purely on speculation, or due to other reasons such as takeover rumors or a short squeeze. In such cases, the investor would be well-served by doing some research to try and ascertain the reason for the stock gains, and depending on the findings, either sell the full position or sell part of the position and put in a stop order to sell the balance if it trades below a certain price. The more that a stock’s short-term gains contribute to your overall portfolio, the more critical the sell decision. For example, if you bought 1,000 shares of a biotech stock at $5 per share when your total portfolio was worth $25,000, that stock constituted 20% of your portfolio. If, after three months, that biotech stock quadrupled on promising trial results while the rest of your portfolio is unchanged, it would now account for 50% of your portfolio. In this situation, it might be prudent to sell some of your shares and book part of the profits, because of the negative impact on your portfolio if the stock retraced most of its advance.
When a stock reaches your price target: Have you ever owned a stock that has been down in the dumps for years, but suddenly has a new lease on life and is now trading at your original entry price? If you promised yourself that you would sell the stock if it ever came back to your buy price, dump it without hesitation (you shouldn’t have been holding on to that loser for so long in the first place, but that’s a subject for another time). Similarly, if a stock reaches a level that it traded at all too briefly in the past, and you always thought that you would sell if it reached that price again, or would consider selling part of your position rather than regret another missed opportunity, then why not sell all of it?… Because of the next point…
When a stock trades at a technical inflection point: When a stock trades near—and then breaks below—a multiyear low, it often portends additional losses ahead. In this case, it may make sense to sell the stock as soon as the technical level is breached on the downside. Likewise, if a stock breaks through a key resistance level on the upside, it may signal more gains and a higher trading range for the stock, which means it might be advisable to sell part of the position rather than all of it. Technical analysts also watch stock price charts closely to identify other signals such as moving average crossovers.
When the fundamentals deteriorate: A stock’s fundamentals may deteriorate for any number of reasons: slowing earnings and/or revenue growth, increased competition, higher costs and lower margins, or simply valuation. The first such signal of deteriorating fundamentals may come from a company’s quarterly earnings report, or sometimes from “guidance” ahead of an earnings report. Market reaction to negative news from a company, such as an earnings miss or lowered forward guidance, tends to be swift and unequivocal, with the stock likely to plunge by double digits. In such cases, the investor needs to determine whether the deterioration in the stock’s fundamentals is temporary or permanent. Since this is no easy task, it might be preferable to sell and exit the position first, then evaluate if it should be bought back later.
When a rival company issues bad news: Often, the problems affecting a specific sector may be highlighted when a bellwether company in that sector reports an earnings miss. If you own stock of a company in that sector, consider selling it unless you are quite confident that your stock will not be affected by the sector’s woes.
When the market looks wobbly: This is no easy task, and is certainly not a suggestion to indulge in market timing, but there are times when the broad market looks overextended; at such times, it makes sense to cull the weaker names in your portfolio. In a financial earthquake, stocks of companies that have a heavy debt burden or a weak financial position might be the first to collapse.
When Should You Sell?
In general, there are some intrinsic reasons to sell a stock—i.e., reasons that are related to the stock itself and/or the markets. In addition, the investor may also have extrinsic reasons to sell; by extrinsic, we mean reasons that are related to the investor’s finances or lifestyle. Occasionally, the sell decision may be triggered by a combination of intrinsic and extrinsic factors.
Let’s look at some intrinsic reasons or factors first.
Selling a Stock Is Hard
Here’s an all-too-common scenario: You buy shares of stock at $25 with the intention of selling it if it reaches $30. The stock hits $30, and you decide to hold out for a couple more dollars in gains. The stock reaches $32, and greed overcomes rationality. Suddenly, the stock price drops back to $29. You tell yourself to just wait until it hits $30 again. This never happens. You finally succumb to frustration and sell at a loss when it hits $23.
In this scenario, it could be said that greed and emotion have overcome rational judgment. The loss was $2 a share, but you actually might have made a profit of $7 when the stock hit its high.
These paper losses might be better ignored than agonized over, but the real question is the investor’s reason for selling or not selling. To remove human nature from the equation in the future, consider using a limit order, which will automatically sell the stock when it reaches your target price. You won’t even have to watch that stock go up and down. You’ll get a notice when your sell order is placed.
If you’ve decided to sell, unload your shares in smart ways.
For starters, sell in tranches over a period of time; Koch says he sells one-fourth of his shares at a time. Whether that happens over one month or several months depends on the market. “Sell on days the market is up to get the best price,” he says. Don’t assume you have to unload all of your shares, either.
“You can take profits in a rising stock, but not get out fully,” says Yoon. “It doesn’t have to be a 100% or 0% decision.” Remember to consider taxes if you hold the shares in a taxable account.
Finally, never sell in a panic. A business you were comfortable with in a smooth market should not be abandoned when volatility picks up. Says Ellis: “Don’t sell when the market goes down.”
A Portfolio Imbalance
Sometimes a good reason to sell shares has more to do with your portfolio than the company.
If your investment allocations are out of whack, you may need to rebalance by selling your winners and buying your losers to get back on track.
Or you may find a better investment.
When Fidelity’s Yoon discovers a new idea – “company B,” he says – with a better potential reward for the risk than a current holding – “company A” – he’ll sell some shares in A to buy B. “Keep in mind the overall goal: To capture the best ideas in a risk-adjusted way that can deliver the best compound returns,” he says.
A Dividend Cut
Dividends are sacred to shareholders and companies alike, so when a firm cuts its dividend, take note.
“It’s certainly an attention-getter and a red flag,” says Drew Lanphear, a Milwaukee CFP. “But it’s important to dig deeper and find out what’s behind it.” Many firms pared or suspended dividends in early 2020 to conserve cash during the pandemic lockdown. But as the economy recovers, most of those payouts could be restored.
Other times, a dividend cut can be a hint of bigger problems, such as too much debt or declining earnings, and you’re better off getting out.
Shares in General Electric (GE) had fallen more than 40%, to $18, in 2017 when the firm cut its quarterly payout 50% in December of that year. Smart investors ditched their shares then – revenues had been relatively flat for years, and earnings were lumpy. Shareholders who hung on suffered more pain in 2018, when GE’s dividend fell to one penny and shares slipped below $10.
A Falling Stock Price
On its own, a falling share price is not reason enough to sell. In fact, it might be a good time to buy. But if the drop in price is tied to a consistent decline in business results – revenues have been declining for more than two years, for example – exiting may be a good idea.
Some investors set a threshold for losses before they’ll sell. If a stock falls 20% from his purchase price, Koch sells. “I manage real people’s money, and my goal is to protect capital. If a stock falls 20% after I buy, I’ve obviously made a mistake. I sell and go to the next idea.”
But Koch can be patient for stocks that go nowhere, another situation that prompts many investors to sell, sometimes prematurely.
In 2015, he bought shares in BlueLinx Holdings (BXC) when stock in the building-products company traded at $7 to $8 a share. “It was dead money for a long time,” he says. But his long-term view was that when home-building stocks prospered, BlueLinx would, too. He was right. Koch sold the stock this year in the mid $40s.
A Lofty Stock Price
It’s hard to let go of winning stocks – typically, they keep winning because the businesses behind them are great. It takes discipline to take some profits off the table.
The folks at Altfest Personal Wealth Management, a New York City advisory firm, understand this. “There’s a lot to like about Apple (AAPL),” says investment strategist and portfolio manager Mayukh Poddar. “It’s a great business, its balance sheet is good, and it dominates its market.” But in 2019, the firm began to reduce its holdings in the stock because it had become “quite expensive” on a variety of measures.
Figuring out if a stock is overpriced requires some work. You must develop a sense of what a business is worth, based on financial statements, the strength of its brand and the competition. It’s the kind of analysis that investors should do before they buy a stock, but often don’t, says Christian Koch, a CFP based in Atlanta.
At a minimum, if a stock price is soaring, make sure that revenues and earnings are still increasing at a commensurate pace. The price-earnings (P/E) ratio is a popular gauge of how expensive a stock is relative to other stocks or to the broad market. The S&P 500 Index currently trades at a P/E of 21, based on estimated earnings for the year ahead.
Stock sectors have their own idiosyncrasies – financials trade at an average of 14 times earnings currently; tech trades at 24. Individual stocks can vary even more. A stock’s high P/E might be justifiable, and a low-P/E stock might be no bargain, so it’s important to consider other factors and other financial measures, such as the ratio of price to sales or price to book value (assets minus liabilities). An annual downward trend in any of these measures could signal a shift in the company’s fortunes.
Some investors set a target – say, a 30% gain – and take their winnings when the goal is reached. That’s not a bad strategy, says Ellis. “You never lose if you take a profit,” she says.