Aug 24, 2014 Investment Education: How to invest – 3 Rules for Selling Stocks
How to invest: 3 Rules for Selling Stocks
Successful investors must consider the best time to buy stock, AND just as important, the best time to sell. Doing so requires a well-defined sell discipline with action required in response to any one of three triggers.
First, you will want to sell a stock if it reaches your price target. This seems obvious, but all too often, we find a way to justify a higher price target when our initial target is reached…particularly if the stock appreciates quickly after the initial purchase.
Next, you will want to sell if the spread to target has narrowed to the point where other investments offer a more favorable risk/reward profile. Most value-oriented investors look for asymmetric layoffs, meaning that the upside is three or four times the downside. For example, let’s say that you bought a stock trading at $12, and based on your analysis, the downside is -16% to $10 and the upside is +58% to $19. In this case, the potential payoff would be 3.5 to 1. If six months hence the stock is now trading at $18, there is still upside to your $19 target but the risk/reward is not nearly as compelling. At this point, you would want to be taking profits and looking for other investment alternatives.
Finally, you will want to sell if it appears that your thesis on the stock is flawed. We are all bound to make mistakes. The key is to recognize those mistakes and move quickly to correct. Stubbornly pressing a bet amidst mounting evidence that the thesis is breaking down can result in significant losses. To mitigate this, complete a thorough review whenever a stock drops -10% from the original purchase price. Ideally, you should either buy more or eliminate the position based on your review.
In summary, reduce or eliminate a position in a stock when:
The stock price converges with your price target
A better risk/reward is offered by another investment opportunity
Your original investment thesis is flawed
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