When Do I Sell?
I get this question from subscribers all the time. It’s probably the question I receive most often.
And, I understand why.
Knowing when to sell an investment is one of the toughest skills an investor has to master. But, it’s a critical skill to have if you want to make money in the market over the long run.
Prior to the tech bubble of the late 1990s and early 2000s, most investors followed a buy and hold approach. All they had to do was continually invest new money in the market and watch it grow.
Very little thought, if any, was given to the question of when to sell.
The conventional wisdom at the time was to hold your investments until you reached retirement age. At retirement, you’d start withdrawing money from your investment portfolio to live on.
But, everything changed when the tech bubble burst in early 2000.
Retirement savings, 401ks, and pension plans were all decimated. Decades worth of savings were literally wiped out in the blink of an eye.
Many of you probably remember.
The S&P 500 peaked in March 2000 at 1,553. Over the next two years, it declined steadily suffering violent day to day swings. The index finally bottomed in October 2002 at 768. When all was said and done, the market had lost more than 50% of its value.
But that wasn’t the worst of the carnage.
The NASDAQ suffered an even worse fate. The tech heavy index fell from a peak of 5,132 to a low of 1,108. That’s a whopping decline of 78%!
Many investors lost everything they had.
But, it didn’t have to work out that way.
If they had merely employed a simple sell discipline, they could have avoided the investor’s worst fear… the catastrophic loss.
A sell discipline is simply a strategy for when you will sell all or a portion of any investment. It’s a set of rules defining the circumstances or conditions under which the investor will sell.
Why is a sell discipline necessary?
It’s necessary because human beings often let emotions get the best of them. And, when our emotions take over, we tend to make bad decisions.
The two emotions that plague investors most are fear and greed.
As an investment climbs in value, nearly every investor will at some point get greedy. They’ll know the investment is overvalued and ripe for profit taking… but, they’ll hang on believing it will only go higher.
Fear takes over when an investor is sitting on a loss. They’ll know the investment didn’t work out and should be sold. But, they hang on to it because they’re afraid of taking a loss. Inevitably, the investment just continues going down and the investor loses a lot more money.
The investor who uses a sell discipline can avoid being done in by their emotions.
So, what sell discipline should you use?
Unfortunately, there’s no single right answer to this question. A sell discipline is a personal strategy that each investor must develop for themselves. There’s no one size fits all.
You see, every investor has different goals, time horizons, risk tolerances, and financial situations. The best sell discipline is the one you develop for yourself taking these various factors into consideration.
With that said, here are some key elements to a successful sell discipline.
- Establish your reasons for the investment. Whether you use fundamental or technical analysis, you should know exactly why you’re investing in any particular security. As soon as you see conditions change for the worse or something unexpected happens, it’s time to sell and look for better opportunities.
- Set an upside price target. This is critical for knowing when to take profits off the table. Before you invest, decide how high you think the investment can go over your time horizon. You can use fundamental and/or technical analysis to calculate the target. You probably won’t get out at the peak every time, but you’ll lock in more profits if you have one.
- Decide where you’re going to exit if the investment goes against you. This is essential for limiting losses on investments that don’t work out as planned. Many investors use a mechanical sell discipline… they’ll exit if the investment drops by a certain percentage from their buy price. Others use technical analysis to identify critical support levels that signal a sell when breached.
These are just a few key elements to a successful sell discipline. You can certainly make yours more detailed and elaborate. The more concrete your sell discipline… the more effective it will be.
Start developing your sell discipline right away. Free yourself from the psychological prison of fear and greed. You’ll suffer a lot less stress and have better success with your investments.
Category: Stocks
