Talking yourself into buying a stock is easy, talking yourself into selling one is much harder, which is why you need a selling strategy before you buy.
It’s easy to buy stock, and it’s generally a pleasant experience. The purchase can make you feel excited, optimistic, even triumphant! However, the day will come when you own a stock that disappoints you, or even scares you. The share price stagnates, or falls, or collapses. Panic can set in. “Why does it keep falling? When will the price go back up? Why can’t I find any news on the stock? Doesn’t Wall Street know what a great company this is?!” Yet, with a selling strategy, you can mitigate these potential negative scenarios. Yes, stocks can be volatile. But that volatility is not caused by voodoo. There are reasons that stocks go up and down.
With a new year approaching, now is the perfect time to look back at this year’s trades, assess which trades didn’t work out (and why) and see if your strategy could use a tune-up. If you don’t have a selling strategy, next year could be the perfect time to implement one.
Develop a Selling Strategy
Let’s talk about developing a selling strategy, so that when things go awry, you aren’t the last person in America left holding a stock that’s fallen 80%.
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There are two types of bullish stock investors: buy-and-hold investors and opportunists.
Buy-and-hold investors would be wise to have a written investment policy statement pertaining to their stock investing. Since they’re generally neither comfortable nor experienced with selling stocks, it’s important that they know, in advance, under what circumstance they will sell.
Here are some examples of simple investment policy statements regarding this selling strategy:
• I will sell stock if the company’s earnings per share (EPS) are expected to grow less than 10% in each of the next two years.
• I will sell stock if its dividend is reduced or omitted.
• I will sell stock if any particular industry makes up more than 20% of my total equity portfolio.
Opportunists are more actively focused on wealth creation than are buy-and-hold investors. They’re less willing to withstand market downturns, and less willing to wait out a company’s period of slow earnings growth.
Opportunists can benefit greatly from market cues that are provided through technical analysis, the study of stock price movement.
The easiest way to identify entry and exit points for a novice chart-reader is to look for predictable trading ranges; then simply buy a quality growth stock when the stock’s at the support level, and sell when the stock’s at the resistance level.
For slightly more advanced chart-readers, an optimal time to purchase a stock is when it breaks above a stable trading range, because it’s likely to experience a nice run-up in the ensuing days and weeks.
Use Stop-Losses as a Selling Strategy to Protect your Capital
Technical analysis not only facilitates trading activity, but it can be used to protect your capital in the event of a sudden or prolonged drop in the share price. When looking at a price chart, identify areas of support based on the trading range or moving averages. One logical place to put a stop-loss order would be just under price support. In that instances, the stop-loss is only triggered in the event that the share price falls below the previously established range.
Some people use stop-loss orders at a fixed dollar amount or a fixed percentage below the current stock price. Then, as the stock rises, they raise the stop-loss order. The stock will eventually have a pullback, and it will automatically sell on the next trade after it hits the stop-loss price. Some trading software automates the process and allows investors to use a selling strategy called a “trailing stop.”
Stock market opportunists use stop-loss orders because they are in the market to make capital gains. They don’t fall in love with their stocks and they don’t want to “go down with the ship.”
One of the biggest reasons I use stop-loss orders is that I love buying low during market corrections. If I occasionally have one stock sell via a stop-loss order, I tend to immediately reinvest the capital into another bullish stock opportunity. But if I have several stocks sell via stop-loss orders within a few days of each other, that’s when I know that the market’s about to have a correction. At that point, I let my money sit in cash, and I wait several days or weeks for the market to bottom. Then, I buy!
How do I know that the market has bottomed? I look at the technical charts of the market indexes. The charts show me where the next support level will be, and I expect the index to bounce there. Then I start buying my favorite undervalued growth stocks while they’re on sale!
You can improve your stock portfolio performance by formulating a selling strategy. What’s more, there’s something very satisfying about having cash available to buy low during market corrections.
Don’t let your stock price hemorrhage when the company’s earnings outlook falls apart.
“But the price will return to my cost basis eventually, right?”
Maybe. Maybe not. But look at it this way: ignore the name of the stock, and think of it as a chunk of money. Then ask yourself, “Will this chunk of money grow more quickly if I leave it in this current, falling stock or will it grow more quickly if I invest it in this other stock that has strong future earnings growth and a bullish chart?” Frankly, the answer is a no-brainer. You pull the plug on the losing stock and purchase a stock that can potentially deliver immediate capital gains. Having a selling strategy is a great way to take the emotion out of trading and put you in a position where you don’t second-guess every trade.
Stock investing is about making money. It’s not about falling in love with an idea, a product or a company, and it’s not about you being a superior, wildly intelligent person versus being a dumb person who loses money. All stock investors have stocks that go down! You can’t avoid it! But you CAN minimize your losses by making wise investment decisions up front and by having a selling strategy in place.
Have a plan. Write it down. And when it’s time to pull the plug on a stock, based on your written rules, don’t let fear paralyze you. You’re never going to improve your stock portfolio performance unless you improve your stock selection strategy and/or your stock exit strategy. That takes practice.
You did not become great at your career or hobbies overnight. You studied and practiced for many years. Your stock portfolio management and performance will benefit greatly when you apply that same intellectual diligence to stock investing that you’ve been applying to your career and talents. You can do this!
What personal rules do you follow as part of your selling strategy?
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*This post has been updated from a version originally published in 2016.