When to Sell a Stock
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You’ve done it! You purchased a stock
Congratulations, you’ve taken a step towards building your wealth! You researched a company, developed a thesis, and purchased a stock. Now it’s time to answer one of the most difficult questions in investing: when do I sell? You look to Twitter and Reddit and see things like “stocks only go up” and “diamond hands.” Unfortunately, stocks do not always go up and if you hold on to a dying company for too long, you’ll likely end up losing money.
But how do you know when the company is going down for good? What if it’s just down temporarily? Should you hold on to the stock and wait for the price to rally back or should you sell?
This brings us to our first point: volatility. Price swings are extremely common in the stock market, so you cannot rely solely on prices to determine whether to buy or sell. Because of this, you’ll need to get comfortable with these upward and (more importantly) downward swings in price, often referred to as volatility.
Dealing with Volatility
Investopedia defines volatility
as:
“...a statistical measure of the dispersion of returns for a given [asset]. In most cases, the higher the volatility, the riskier the [asset]. Volatility is often measured as either the standard deviation or variance between returns from that same [asset].”
In other words, volatility is a mathematical way to express how much the price of a stock swings. As we stated above, volatility is normal in the stock market. However, some stocks are more volatile than others and are therefore considered “riskier” for investors. There are essentially no stocks that will provide a constant upward price movement, so no matter how you’ve composed your portfolio, you’ll need to be able to handle volatility.
When a stock price drops, you’ll need to be able to assess the situation without “panic selling” due to fear of losing money. Try to figure out why the price is dropping. Did the company get hit with a lawsuit? Were they in the press with bad news? Did the company’s leadership change? Was there a political shakeup? Or does the entire market seem down today? Some of these things may be short term problems that do not change your overall thesis for the company. If that’s the case, you may want to hold on to the stock. If the price drops due to something that factored heavily into your thesis (e.g., a new CEO is brought in), you may need to assess whether or not you still believe strongly enough in this company to hold their stock.
Let’s take a look at a few factors to analyze prior to selling.
Macroeconomic Factors
What is macroeconomics? The macroeconomy is concerned with large-scale or general economic factors, such as interest rates from central banking agencies, national productivity, loan health, and unemployment. A recent major macroeconomic factor was the COVID-19 pandemic, which led to a massive sell off in March of 2020. Major economic crashes can be financially stressful for individuals, causing them to liquidate their stock holdings to provide for themselves and their families. When many investors do this, major sell-offs occur and stock prices plummet. Although some investors have proven skillful in predicting and profiting from market crashes (selling when prices are high and re-buying after the crashes occur), it needs to be noted that timing the market in this way is extremely difficult for the vast majority of investors (more on market timing below).
The macroeconomic environment should particularly be considered when specific industries are hit. For an example, let’s again return to the COVID-19 pandemic. Pandemic-related travel restrictions significantly affected air travel, causing many major airlines to shut down (and subsequently lose revenue). Although many restrictions are now lifted and more people are traveling, stocks for major airlines (e.g., Delta, American) remain below pre-pandemic price points. If you owned stock in one of these companies, you should assess how the company responded to changes in the macro environment and whether you think their response strengthened or weakened your thesis. I am not a financial advisor and you will ultimately have to make the decision to buy and sell a stock at times of your choosing.
Microeconomic Factors
The microeconomy involves market mechanisms that establish relative prices among goods and services and that allocate limited resources among alternative uses. This can be changes in certain goods and services that would affect the overall business. Take the oil and gas industry as a broad example. The price of oil and gas changes frequently, and these fluctuations can drastically affect how much a company like Exxon or Shell can make in a given year. Ultimately, these factors could affect a company’s margins and revenue and can therefore lead to fluctuations in stock prices. Similar to macroeconomic factors, if these microeconomic factors change your thesis then you should reevaluate your position.
Specific Business Changes
Business changes can affect your views as a shareholder. Some factors that could change a business include: change in ownership or leadership, an investment or acquisition into a less familiar sector, changes in supply chain, changes in operating expenses or expense allocation, and much more. Fortunately for investors, public companies are required to disclose the in’s and out’s of the business quarterly and annually. These quarterly and annual reports allow investors to determine whether the information presented affect your thesis on why you initially invested in the company. Warren Buffet has famously said, “when you initially purchase a share of a company, you should purchase it with the intent of never having to sell.” Change can sometimes be a good thing for a company, so you should not always sell at the sign of change. Take Apple as an example. When Tim Cook took over 10 years ago, Apple did not miss a beat. In fact, Apple’s stock has taken off and significantly outperformed the S&P 500, check out the chart from MSNBC below.
I Bet I can Time the Market
This is a bet I don’t think is worth taking. Rather than trying to time the market, some suggest that a “buy and hold” strategy is best. And some data tend to back this hypothesis. Below is a figure that shows ranges of S&P 500 returns had you purchased in any year from 1926-2011. The figure demonstrates the benefits of holding the S&P 500 for longer periods of time (1-year, 3-year, 5-year, 10-year, and 20-year periods). As you will see, the potential for negative returns (losses) is much larger over shorter time periods. In fact, between 1926 and 2011, a 20-year holding period never produced a negative result.
If you attempt to time the market and for some reason miss even just a few of the top days, your returns can be severely affected.
Both of these charts were obtained from Investopedia.
Overall, it is very difficult to time the market and if you make a mistake it can cost you a substantial amount of money. Rapidly buying and selling stocks can also incur trading fees and your earnings can be taxed (this is a topic for another day). In my opinion, you should hold a stock through the bumpy roads and try to zoom out to see the bigger picture. Once you zoom out you’ll see that, despite short term volatility, stock prices of solid companies generally go up in the long term. Therefore, buying and holding is the simplest method to build long term wealth in the stock market.
We hope this article was helpful! The best time to get started in the stock market was 5 years ago and the second best time is today, so get out there and do your research!
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When to Sell a Stock
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Disclosure:
The article was written by Daniel Kuhman and Brandon Keys, and it expresses the author's own opinions. The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock, asset, or cryptocurrency. Brandon and Daniel are not financial advisors. We encourage all readers to do further research and do your own due diligence before making any investments.