Last Updated on January 15, 2019 by Sultan Beardsley
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An important concept to understand when you start out investing is; “how do you know when to sell your stock?” The answer involves consideration of several factors and your strategy.
Formation of an Investment Thesis
Setting a Price Target
Risk Aversion/Fundamentals Change
Form An Investment Thesis
The reason you want to buy a stock is to hold it and sell it at a later point in time for a greater price (i.e. make a profit). The golden question is how do you know if a stock will rise in value over time or if it’ll go down? You do research (i.e. “due diligence”) and form a factual, evidence based thesis justifying why s company is either fairly valued or undervalued, and will go up in price over a certain period of time. So long as your investment thesis remains intact you do not sell unless your price target is reached. Your stock might decrease in value in the short-term. Don’t panic and sell. That is probably one of the top rookie mistakes. If you liked the company at a higher price than shouldn’t you like it even more at a lower price? In this situation we would simply buy more. This is called “averaging down”. However, if the stock went down because something fundamental changed and your thesis is no longer intact then you would sell. Bottomline, make investment decision based on logic and reason rather than emotion and fear.
You’ve completed your fundamental analysis/due diligence and purchase your shares. Now you must set a price target. Many investors look to top analysts and their speculation for future price as a basis of their own, but it’s important to remember this is speculative and analysts aren’t always right. Regardless, this sets a nice ballpark for investors to base potential goals on. Price targets are a crucial piece of your investment strategy as it ensures that greed doesn’t cause you to lose money.
A perfect example of where price targets can save your portfolio and keep you on track to the gains you wish to see is Galt.
As seen left, GALT experienced a sizable run from some news perceived as favorable to investors. Peaking at $9.50, the stock dropped in 3-months to nearly $3. Investors who had followed their pre planned price targets and realized these rapid gains would have been positioned to roll the gains over into cheaper shares after the price returned to baseline. In essence the GALT experience demonstrated that it is paramount to not get greedy and remain true to a plan, realizing gains and shutting down the “what if’s?”.
The takeaway is; set a realistic price target, stick to your plan and don’t get greedy. If your stock ever goes up 180% in 2-months take some profit.
Successful investors typical find themselves using a combination of techniques when trading. The same comes to play with “when to sell a stock.” Technical Indicators such as RSI and MACD assist in communicating the narrative investors attempt to crack. These indicators are at times foretelling of price-trajectory. In other other words they may alert investors to impending downside (i.e. a good time to sell). We will leave the details of how these methods work in their respective articles on MS Money Moves.
The takeaways from technical indicators; They are potentially foretelling of a good exit; they add value to your overall exit by setting another data point to guide your decision making.
Risk Aversion/Fundamentals Change
Many companies in todays bear market seem to be getting punished beyond comprehension. Companies such as VSTM have witnessed nearly -67% since FDA approval of their drug duvelisib. Many investors argue the price prior to approval had been propped up on speculation of approval and was due for downside regardless of the result. Although this may be the case, it provides a perfect lens for new investors to observe headwinds to your investment thesis.
At times you may do all the due diligence necessary, but the markets place little value on your pick such as VSTM. It is just as important to plan for downside as upside. Many investors protect their investments with what is known as a stop loss. This is designed to let go of your shares at price X as you are only willing to witness that specified amount of loss.
It is important to remember your investment thesis and whether anything has changed at times like these. Often times investors are cheated out of their shares at such low levels, soon missing out on the upside they had anticipated. Ask yourself this-has anything changed to effect your initial thesis outside of the general markets? Remember, you have not actually lost any money unless you sell.
Additionally, this may assist in designing your exit at a loss if things take a turn for the worst. If you conclude that your thesis remains true, it may provide for a perfect opportunity to average down and decrease your purchase price. This brings your breakeven point down and maximizes future upside. This can be observed in the image left.
Knowing when to sell is dependent on strategy, but is generally best pursued through a multitude of practices and tools. Price targets are traditionally built into an investment thesis towards the end as the analysis has provided you with insight into potential upside. This price serves as an integral part of your strategy, ensuring downside is mitigated and more importantly that you don’t get to greedy on an investment and fall prey to “what if’s” that many bulls throw around.
Technical indicators can provide insight into a change in price movement, mitigating risk and maximizing upside. Although they are not 100% accurate, they provide investors with another tool to strengthen their strategy and maximize profit when exiting a stock, or minimize loss when exiting a poor investment.
Although people rarely talk about losses, it is important to recognize that you will at some point be faced with downside. When this occurs it is important to examine whether the observed downside is due to a fundamental change, the stock is oversold, or undervalued by the market. The latter is a gift allowing you to average down maximizing gains. In order to do this you must be aware of your risk aversion and plan for any outcome to formulate a sound working thesis.
Remember; “we don’t marry a stock, we date them”
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