No matter what year it is, and no matter what the market environment, the most common questions we field at Cabot Growth Investor concern selling. It makes sense; when you’re buying shares, you’re full of hope and dreaming of big profits—it’s easy to think about the what, when, and how much of buying.
But selling is another beast altogether. When you sell your stock, you’re giving up hope, essentially eliminating any possibility of greater profits. Mentally, it can be tough to do, which is why it’s so important to develop a set of rules and tools; in the heat of the moment, a set of sound rules will give you a path to follow.
Here are some of our most fundamental selling tools and rules:
1. Cut losses short This is, was, and always will be the cardinal rule for growth stock investors; you never want your loss from your cost basis to exceed 15% to 20%; if you’re on your toes, you’ll likely get rid of a loser at 10% or less. (We’re not talking about trailing stops, which are often counterproductive.) Even if you sell and watch the stock go up afterward, don’t fret; this rule is meant as insurance against the occasional catastrophe, when your stock collapses 50% or more as the company’s fortunes change.
2. Never let a solid profit turn into a loss This is a common mistake. If you develop a 15% to 20% profit in a stock, and things begin to head south, you shouldn’t allow the stock to fall all the way back to your buy price. Notice that this and the first rule of selling concern protecting your capital. If you’re able to accomplish that goal, it’s simply a matter of time before you nail down some big winners that propel your portfolio higher.
3. After an extended rise, sell on a big-volume break below the 50-day moving average Institutions tend to add to winning positions after a stock has dipped to its 50-day line, so if a leading stock clearly breaks its 50-day on big volume, it’s saying that institutions are not only failing to support the stock, they’re dumping it! And that often tells you a longer, deeper base-building period (at best) is upcoming, so selling at least some of your shares is prudent.
4. Huge downside volume is a red flag If a stock falls sharply on triple normal volume, it’s telling you big investors are bailing out. That’s not always a sign to sell, but you should put your stock on probation; demand that it hold up and begin to advance in the days following the drop. If it doesn’t, that’s a good indication that some sort of top has been put in.
5. Sell after an out-sized negative reaction to an earnings report Earnings season can make or break a stock. If you witness a huge gap down (more than 10% or 15%, usually through a major support level like the 50-day line) right after a company’s quarterly report, you should sell. Even though you’ll feel “late” in selling after a big drop, our studies show that most big earnings-induced gap downs lead to lower prices in the ensuing weeks.
6. After an extended rise, consider selling some shares on abnormal strength We believe that “offensive selling” can help you keep a good portion of your profits. In this case, abnormal strength might mean a 20% to 40% jump in just a week or two (or less!) after a multi-month rise, possibly on some good news (an upgrade, a stock split, a new contract, a new CEO, etc.). While such news probably contains longer-term positives, many institutions will sell into such strength, so taking a few chips off the table is prudent.
7. Consider selling a piece of a big winner when market timing turns negative If the Cabot Tides and Two-Second Indicator turn bearish, it’s likely most stocks are going to have a rough time in the weeks to come. So if you have a big winning stock, consider selling a quarter or third of your shares, ringing the cash register and raising some cash.
8. Remember that you can always buy a stock back This is an important psychological tool. Too many investors believe selling is an all-or-nothing decision, but with commissions so small these days, you can freely get back into a stock. You shouldn’t hesitate to sell simply because you fear the stock will run higher without you; if the stock resumes its advance, you can get back on board.