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Determining the right time to sell a stock is arguably one of the most challenging dilemmas faced by investors, both seasoned and novice alike.
Should you realize profits? Cut your losses? Or, as Warren Buffett advocates for select stocks, hold indefinitely?
Let Your Winners Run
When a stock is thriving and the company behind it is growing and profitable, there may be little reason to consider selling. If you were the owner of a successful hamburger stand, would you consider selling it simply because it was surpassing your original sales projections? Likely not. You would capitalize on its success instead.
A fundamental investor might opt to sell only when their outlook on the company’s future changes significantly, such as recognizing that the best days are behind it or that its current price no longer reflects its intrinsic value.
Otherwise, if a stock continues to perform well, allowing it to appreciate further can harness the power of compounding returns.
Cut Your Losers
It’s important to acknowledge that not every investment will yield positive returns, and when stocks underperform, having a strategy for exiting those positions is crucial. Remember, selling off losing stocks can be a part of tax-loss harvesting, which may benefit your tax situation.
While occasional small losses are manageable, accumulating significant losses can greatly impair overall portfolio performance. Setting a stop-loss order is a straightforward way to ensure that losses remain controlled. This is where you instruct your broker to sell a stock should it dip to a predetermined price.
For example, if you purchase a stock at $10 per share and decide you can risk a maximum of $2 per share, placing a stop-loss order at $8 will trigger a sale if the stock falls below that price. Different investors may have varying criteria for setting stop-loss levels; some may follow the advice of William O’Neil, who suggests exiting a position that drops 7% to 8% from your entry point. Others might prefer a trailing stop, which sells the stock when it drops a specified percentage from its highest value.
In the earlier example, if your stock rose to $15 and then declined, a 10% trailing stop would trigger a sale at $13.50. Finding the optimal stop-loss strategy requires balancing enough flexibility to account for normal fluctuations while still protecting against substantial losses.
Controlling Risk
As mentioned, stocks that are performing well generally do not necessitate an immediate sale. The exception arises when a single stock begins to represent an outsized portion of your overall portfolio. In such cases, portfolio rebalancing may warrant the consideration of selling to reduce this concentration risk.
For those with smaller trading accounts compared to, for instance, a larger retirement account, a few winning stocks might not materially impact financial stability. However, if a significant portion of your net worth is concentrated in a small number of stocks, vigilance is needed, particularly regarding potential capital gains taxes when selling.
Though it’s not necessary to sell immediately upon reaching a dominant position, having a plan is essential. This could involve initiating stop-loss orders to gradually sell portions of the stock at various price points, rather than liquidating the entire position at once.
Avoiding emotional attachment to stocks is crucial. A strong emotional connection can cloud judgment, leading to decisions that are not aligned with objective analysis and investment goals. The key is to execute selling decisions based on a methodical approach, ensuring that they are consistent with your overall investing strategy.
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