So you have stocks that are sitting at profit and you are itching to sell. Congratulation! Now, the question is, is this a good time to sell stocks? If yes, then which one should you sell now and which ones should you wait to sell?
What is Your Stock Profit Taking Strategy?
Do you have one? You may not have written it down on paper, but instinctively you have some idea of when you would want to sell. However, what you know in theory may not be easy to execute in practice. Let me help you clarify the reasoning.
There are 2 main philosophies of thought around the question of selling stocks.
1. Sell Stocks when they are Fully Valued
This is the way traditional value investors go about their business. The idea is that once you buy stocks when they are undervalued, so it logically makes sense to sell when the stocks are no longer undervalued. Ergo, when the stocks are profitable and reach their full valuation, there is no compelling reason to hold them. In this scenario, investors will sell these stocks and take profits.
This is the way I approached my investing. Once we have the profits we desired and expected, it is time to take the money out of that investment so it can be reinvested in a new investment. However, over time my thinking around selling has changed. I now have a different approach and I will outline it in the next section. Before that, let me explain the reasons why we may want to reconsider how we sell stocks, if you currently sell your stocks when they are fully valued.
- You will leave some profits on the table. In my experience, when value stocks rise, they do not stop rising when they reach full valuation. They generally overshoot my target, on average by about 30%. It is hard to say when the peak will arrive, but I am sure the best time to sell these stocks is not at full valuation but a little bit after that. There may be ways to let the winners run further. It turns out there is and it comes from the trading desks. More on this later.
- Fully valued stock may still grow if the underlying business continues to grow at a good clip. Classic value investors pay not much heed to future growth prospects, but good companies with strong competitive advantage can continue to grow their market for a long time. Fair value of the stock today is likely undervalued on tomorrow’s fundamentals.
This of course applies only to when you have a profit in the stock you are considering selling. For other situations that may make selling advisable, learn more about my ideas on when to sell stocks here.
2. Sell Stocks when they Appear to have Reached their Peak
This is the preferred way. It is not my intention to suggest that we try and time the market. We are value investors at heart. What we suggest that once the stock has crossed our desired profit mark, we set up tight trailing stops. This will give us additional profit if the stock continues to increase. On the other hand, if the stock begins to decline, we will sell when the stop hits – which is still higher than our original full valuation selling price.
I can foresee many objections to this method.
First, it does not sound like something a value investor would do. After all, we are not supposed to chase prices in the stock market. For most liquid stocks, we are doing everything that a value investor does, but we are doing a little bit extra to gin up the profit.
Second, this will not work on illiquid stocks. Small stocks tend to be illiquid and also tend to be where most value stocks lie. This argument is totally correct. In such situations, you will not use this method. Investing requires us to be judicious and use our experience to guide us.
Third, by staying longer than necessary in the stock, we are exposing ourselves to very real financial risk – the risk that the stock will not able to hold its valuation and can collapse and we will lose the profit we had in the bag. Again, tight stops will help in this situation by forcing us to sell quickly when necessary. Many value investors may find this completely unnecessary, and that is perfectly fine. You should invest in the way that you are comfortable – I present this as a possible option you may not have considered when selling your stocks.
I will suggest another important point. Most investors, even experienced value investors, often slip in their determination to sell their stock when it appears to be doing well. It is very tempting to wait just a little bit more and sell your stock a little bit higher. This is very risky trading. If we are all doomed to do this one time or another in our investment career, perhaps adding a tight stop limit to the order is an extra bit of insurance that we do not get carried away by our greed.
How do You View Money Sitting in Cash?
Investors generally do not like to see their money sitting in cash. Money that is not invested in the market is the money that is not generating profit. With the typical interest rates lower than the rate of inflation, idle cash is also deadly – it actually erodes your purchasing power.
However, value investors like to have available cash to invest at all times. Great opportunities often come un-announced and it is terrible to be caught with no cash to deploy. Cash, therefore gives us an option – to be able to take advantage of an opportunity at any time. What do you think is the value of this option? I personally feel this is priceless.
It is for this reason that I am never in a hurry to invest the cash I receive when I sell my stocks with profits, or when I receive a dividend. When I come across an investment that screams to be bought, I will spend the cash. However, if I do not find such an investment, I wait ready and able to deploy my money as needed.
You may Never Sell Your Best Financial Investment
Have you considered that selling your stocks is not always the best option? If you own stocks that are under valued or fairly valued, you may want to continue holding these stocks forever in certain conditions, such as,
- tax impact of selling is substantial. If you are staring at a large tax bill if you sell, perhaps it may be a better idea to bequeath you assets to a charity of shelter it in a trust. Consult with your advisors on this.
- dividend earnings from the stock is a consistent and growing income stream for you and you would like to keep it
- the company maintains a sustainable competitive advantage that ensures that its earnings will continue to grow in the future at a pace faster than the market.
If any of the above conditions are true, consider selling your stocks very carefully. It may not be the best option.
Selling Stocks for Profits is a Personal Decision Each Investor Needs to Make Based on their Trading Philosophy
As I said, your approach to investing and trading will determine the best way to sell (or not sell) stocks that have accumulated profits. Investing is not an exact science and your decisions need to make financial sense to you and be in line with your investing philosophy.