Knowing When to Sell Key to Investing in Stocks Success - Part I
There are two important events in the investing cycle that determine whether you will make a profit or not. The first event is determining what price you will pay for a stock. The second event, which is equally if not more important, is determining under what circumstances you will sell.
Too many investors focus only on buying a stock and lose track of their strategy when it comes time to sell. It is important to have a plan in mind for when you will exit a stock so that you are not subject to making an emotional decision when things change dramatically in the stock market.
Of course, it is important to buy stock at the right price. If you don't do this, it is difficult if not impossible to make a profit. However, an emotional decision when it comes time to sell can wipe out any profits you have made or cut off any future profits they could have made from the stock.
Before you buy a stock, you should also have in mind the circumstances under which you would sell. Some of the circumstances you can control, but many others are beyond your control and it is best to have a plan in place to deal with these circumstances before they happen. For example, what will you do if the price of your stock drops by 15%? Will you sell or will you hold on until the prices dropped even further.
There is not necessarily a correct answer. The answer you come up with must fit your financial plans and more importantly your tolerance for risk. Your plan must also consider whether the drop in price was due to market conditions or a change in fundamentals for the company. This is why it is important that long-term investors continually review the companies they have bought for any changes that may affect the market price.
You also must consider the possibility that your initial analysis of the company was flawed or overlooked some important factor than now has caused a weakening of the fundamental strengths of the company. This is why having a margin of error is important for every investor, since it gives you some room to sell if the price starts dropping and you realize you have made a mistake in your analysis of the company.
You might also want to consider that if the price of the stock has risen dramatically over a short period, you may have too much money in this one security and need to move some of it at least into other areas to protect your diversification. This is called rebalancing your portfolio and it is an important safeguard for long-term investors. If done correctly you will not have too much money invested in a single security or a single area of your portfolio due to the dramatic rise in price or a dramatic fall in price.
In the category of good news-bad news, you may find this circumstance where the stock has dramatically risen above its intrinsic value. If you bought the stock below intrinsic value and have watched it rise dramatically over a period of time congratulate yourself on a good investment, but remember the stock market as a way of correcting exuberance. At some point, the market is going to realize the stock is way overpriced and will make a correction, which is another word for selling off a substantial amount of stock.
If you're still holding the stock when this happens, you will watch a lot of paper profits evaporate very quickly. Part of your investing strategy should always be: at what point do I take profits off the table and reinvest them someplace else.
This doesn't mean you have to sell your entire stake in the stock, but a prudent position would be used to sell enough to cover your original investment. Then, what remains is profit, roughly speaking. If the stock keeps going up so much the better, but it is headed for a fall at least you have protected your investment by pulling out your original capital.
Too many investors focus only on buying a stock and lose track of their strategy when it comes time to sell. It is important to have a plan in mind for when you will exit a stock so that you are not subject to making an emotional decision when things change dramatically in the stock market.
Of course, it is important to buy stock at the right price. If you don't do this, it is difficult if not impossible to make a profit. However, an emotional decision when it comes time to sell can wipe out any profits you have made or cut off any future profits they could have made from the stock.
Before you buy a stock, you should also have in mind the circumstances under which you would sell. Some of the circumstances you can control, but many others are beyond your control and it is best to have a plan in place to deal with these circumstances before they happen. For example, what will you do if the price of your stock drops by 15%? Will you sell or will you hold on until the prices dropped even further.
There is not necessarily a correct answer. The answer you come up with must fit your financial plans and more importantly your tolerance for risk. Your plan must also consider whether the drop in price was due to market conditions or a change in fundamentals for the company. This is why it is important that long-term investors continually review the companies they have bought for any changes that may affect the market price.
You also must consider the possibility that your initial analysis of the company was flawed or overlooked some important factor than now has caused a weakening of the fundamental strengths of the company. This is why having a margin of error is important for every investor, since it gives you some room to sell if the price starts dropping and you realize you have made a mistake in your analysis of the company.
You might also want to consider that if the price of the stock has risen dramatically over a short period, you may have too much money in this one security and need to move some of it at least into other areas to protect your diversification. This is called rebalancing your portfolio and it is an important safeguard for long-term investors. If done correctly you will not have too much money invested in a single security or a single area of your portfolio due to the dramatic rise in price or a dramatic fall in price.
In the category of good news-bad news, you may find this circumstance where the stock has dramatically risen above its intrinsic value. If you bought the stock below intrinsic value and have watched it rise dramatically over a period of time congratulate yourself on a good investment, but remember the stock market as a way of correcting exuberance. At some point, the market is going to realize the stock is way overpriced and will make a correction, which is another word for selling off a substantial amount of stock.
If you're still holding the stock when this happens, you will watch a lot of paper profits evaporate very quickly. Part of your investing strategy should always be: at what point do I take profits off the table and reinvest them someplace else.
This doesn't mean you have to sell your entire stake in the stock, but a prudent position would be used to sell enough to cover your original investment. Then, what remains is profit, roughly speaking. If the stock keeps going up so much the better, but it is headed for a fall at least you have protected your investment by pulling out your original capital.
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