I have been investing in the markets for over 4 years and during this time I have made many mistakes but fortunately I have learned from my mistakes and as a result saw positive returns from my investments. I believe anyone can be a good investor by following these simple steps to improve their portfolio management skills.
Deciding when to sell a stock challenges even the best professional investors because there are so many variables to think about.
These are seven common reasons to sell:
- Something has changed to the investment case since you bought the stock
- The valuation has become too rich
- You find a better investment idea
- You are losing sleep because you regret investing in something
- You need the money
- To rebalance your portfolio
- The share price has slumped and you’re cutting your losses.
Some investors are opportunistic, hunting for short-term trades where they believe they make good returns in anything from a few weeks to several months. They will typically set a target level, perhaps 30% or 40% above the buy price, at which point they will sell.
Having a target can be helpful, although it does take discipline. It can help control human emotions which sometimes cause people to become either too greedy or blind to their own mistakes and make more bad decisions.
Targets can work on the downside too, by using stop losses, a fixed point below your buy price at which a sell order is automatically triggered if things go wrong. But targets have limitations. Deciding to sell too quickly because you have hit a target price can cap your chance of earning higher returns for longer if you were more patient. Equally, sometimes companies suffer short-term setbacks from which they can bounce back in time. Getting ‘stopped out’ will limit your exposure to even deeper losses, but it will also prevent you benefiting from any longer-run recovery.
WHEN DO LONG-TERM INVESTORS SELL?
Most ordinary investors follow the buy and hold approach, looking for stocks they can own for the long-term. Well-known investors like Terry Smith, Nick Train and Warren Buffett also follow this strategy. They tend to look for high quality stocks, namely businesses with great products and services, trusted brands, sensible management and a good track record, capable of producing above-average returns for years to come.
But even these investors will offload stocks at some point, so what might make them push the sell button? It’s normally because the company isn’t progressing as they originally expected. Or the valuation has got too high, so they see an opportunity to lock in a profit while the going is good, before the price follows mean reversion and eventually adjusts to a more normal valuation.
GETTING A RISK-FREE RIDE
If you are fortunate, you might see one of your stocks increase in price a lot. That is bound to make you think about cashing in, yet many people will also want to stay invested, so they don’t miss out if the price keeps going up. It’s a nice problem to have, but a problem all the same.
One way to manage this situation is to take some of your profit and still retain some of your shares. How much profit you take is up to you but often people take enough profit to cover their original investment, which then gives them a completely risk-free ride on future share price gains.
For example, if you initially paid £500 for shares in a company and the stake is now worth £1,800, you’d sell £500 worth of stock, covering your costs and leaving you with a still- significant stake in future upside.
DON’T PANIC SELL
Stock markets go up and down which is completely normal as they reflect world events, politics, company performance and a million other things, but investors should never sell in a panic. Investors should not fear occasional swings in the market, but spells of extremely volatile behaviour should be used to reassess your portfolio.
There is no bulletproof strategy on the right time to sell, but the key is having a disciplined policy on why you buy, how long you hold, and when you sell. If you can be disciplined over the long-term you can have a better chance of growing your investment pot down the line.
CLASSIC MISTAKES MADE BY INVESTORS
- Being greedy. Investors can get carried away when share prices are rising strongly as they assume the stock will go up for ever.
- Falling in love with an investment and becoming a fan rather than a hard-nosed investor. Critically reassessing the investment regularly should help.
- Succumbing to fear. Temporary short-term problems can often cause significant price falls if investors don’t have long enough time horizons. With no patience, investors will sell because they think that the problems will mean the shares won’t go up for a while. If enough investors do this, the shares are likely to decline much further which can cause a panic, as other investors assume the problems are worse than they realised. This is when rational long-term investors can invest for great long-term returns by buying during periods of fear with a contrarian mindset.
- Panicking when markets are falling. We all hate to see screens of flashing red prices when stock markets crash. Investors need to keep their cool and ask if the investment case has changed for each company in their portfolio. If nothing has changed, do not panic sell.
- Action through boredom. Investors can be tempted to trade too much, chasing the next hot stock or new idea. Trading incurs costs which can add up over time.
I hope you navigate the stock market effectively and avoid the mistake most people (including me) often make.
Nazrul Hoque – 01 September 2020