It’s one of the most unpleasant topics to discuss in investing. Most investors try to ignore it and hope it will go away. But if you want to profit as an investor, you have to know when to sell stocks at a loss.
It’s understandable that we avoid the topic. No one wants to lose money. There’s always a chance that if you can just hold on, your stock that’s sinking like your favorite pair of sunglasses that you dropped in the lake will magically stop falling and come back up. That’s definitely true with some stocks. They all go up and down here and there.
One look at the charts from 2020 is evidence that even the best stocks on the market can crash. It’s also evidence that many stocks can rebound quite nicely. Crashes aside, however, some stocks lose value and never recover. Anything from poor sales to poor management to ongoing scandals to bankruptcy can destroy a stock’s value.
For investors, however, it’s important that we can tell the difference between good stocks that are having a bad quarter and bad stocks that we need to let go of. And in both cases, our portfolios will benefit if we know when to sell stocks at a loss.
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Find out when to sell stocks at a loss (and when to hold on for the long haul)
Let’s step back to 1978 for a moment. A song written by Don Schlitz and recorded by Kenny Rogers was all over the charts. It won Grammys for both artists, and Rogers performed the song the following year on an episode of The Muppets. (Which is better than a Grammy, in our opinion.) If you know the words, sing along.
You’ve got to know when to hold ‘em
Know when to fold ‘em
Know when to walk away
And know when to run
While we know The Gambler was a song about a fictional train ride with a fictional character, this isn’t bad advice for determining when to sell stocks at a loss.
One caveat before we go any further: When we talk about selling stocks here, we’re referring to stocks that you buy with the intent of holding them long-term. These could be value stocks or growth stocks. They could be dividend stocks or not. They could even be speculative stocks. The point is that we’re looking at growing your portfolio over the long term. And when prices start to drop, you need to know when to sell stocks at a loss to protect your overall gains.
We have three basic rules when it comes to investing:
- Be patient. Let your winning stocks keep winning.
- Take partial profits on the way up. That way, you’ll never have a total loss.
- Set a loss limit. This will vary depending on the stock and your risk tolerance, but we generally suggest between 10% and 20%.
That seems simple enough. You buy a stock for $15. It gradually rises. You sell enough to regain your initial investment. The stock hits $30. Then it drops to $28. No big deal. There’s no bad news, so people are probably just taking some profits. Plus, we know that stocks go up and down over time. It hits $40. This is good! You sell a little more and take some profit.
Then it drops 10%. You look at the most recent earnings reports, check the 50-day moving average, scour the news.
Barring any detrimental news, this is where you have to look at the facts, starting with your risk tolerance. Can you emotionally and financially handle a 10% loss on this stock? How much will it hurt your portfolio? If you have 30 stocks in your stable, probably not a lot. If you have 10 stocks? That’s a different story.
Consider, too, what kind of stock this is. Some industries are naturally more volatile than others.
But these are things you need to consider in advance. There’s too much emotion involved in trying to make these decisions in the moment. Maybe you’re okay holding on until you have a 15% loss – or even 20%.
Whatever that number is, once you’ve decided on your loss limit, stick to it! We know that cutting stock market losses short is the rule that investors follow the least. And, yes, it hurts when you sell a stock that turns around and brings in eye-popping returns. But selling stocks before they can do serious damage to your portfolio is the best way to preserve the gains among your winning stocks.
One last bit of advice is to follow us here at Cabot Wealth Network. It’s our job to give you the information you need to make smart investing decisions. There is a lot of free advice on our website and several free reports you can download and read. And when you’re ready, we also offer a wide range of award-winning investment advisories where we share the latest investing information and tips.
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*This post has been updated from a previously published version.