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How to know when to sell your stocks

As an investor you might ask yourself a frequent question as to when you should sell my stocks to reap benefits. The answer to this question is often as difficult and individual as deciding when to buy a stock.
You already know that frictional expenses can make buying and selling stocks in rapid-trading fashion seriously lower your returns.
There appears to be two main reasons that can help you determine the answer to the above question:

  1. If upon buying shares, you later realise that errors were committed in the analysis – errors which fundamentally affect the business as a suitable investment – then you should sell even if it means a loss will be incurred. Remember, the key to successful investing is to rely on your data and analysis instead of Mr. Market’s emotional mood swings. It is possible that the stock price can go up even after you sell, causing you to realise your mistake.  Everyone will make mistake and also learn from it.
  2. It’s very possible that upon buying shares, the stock price, for one reason or the other, rises dramatically in a short period of time. The best investors are the most humble investors. One’s chances of making money in the stock market over the long run increases significantly if you buy cheaply. But a cheap stock can become an expensive stock in a very short period of time for a host of reasons. Take your gain and move on. The share prices may decline later and you’ll be presented with the opportunity to buy again.
  3. The value of any stock or share ultimately rests on the present value on the company’s future cash flows. Valuation will always carry a degree of imprecision because anything in the future is uncertain. Hence this is why value investors rely heavily on the concept of the margin of safety concept in investing.

Usually the best clue for when to sell a stock comes from the issuing company, itself. One sure sign of trouble is if a company is having cash-flow problems, i.e. the cash it receives and the cash it pays out. You can find the information in the company’s annual reports, accessible on its Web site, or other sites.
Ideally, you sell a stock when it’s up so you can make a profit. But sometimes you have to cut your losses and sell when a stock is down. It’s incredibly easy to get tripped up in the stock market. Companies rise and fall at lightning speed, and information transmitted so quickly that the smallest tidbit of news can send shares soaring or falling in a single day. When the market fluctuates so often, it makes it extremely difficult to stay focused on the intrinsic value of a stock.
The buy price also plays a significant role in determining the sell price of a particular investment instrument. The ultimate return one will gain on any investment is first determined by the buy price. Indeed, while buying at the right price may ultimately determine the profit gained, selling at the right price guarantees the actual profit, if any.
There are certain rules to every business and the same is true when buying or selling stocks or shares.

Rule 1. Every stock has a fundamental value, obtained by discounting the company’s expected future earnings.  As a general rule, you should buy a stock below its fundamental value and sell it when its price reaches or exceeds the fundamental value. The difference between the two prices is the gain that you make. However, there is an exception to this rule. Some external or company-specific factors can alter a company’s business prospects.
Rule 2. Although knowing the fundamental value of a stock is core to a sell-decision, the process of calculating it can be extremely complicated. Whenever it is below the low end of the range, it is a buy signal. On the other hand, if it moves over the range’s high end, it indicates a sell.
Rule 3. Company’s earning yield is the reciprocal of PE multiple. PE multiple means the price you pay for each rupee of the company’s earning. So, its reciprocal, earning yield, would mean the amount that the company returns (earn) on each rupee that you paid to buy its share.
Rule 4. The need to maintain a well-diversified portfolio is another reason to sell a stock. The value of a company’s shares in your portfolio could double or triple in a short span. For example, suppose your stocks portfolio is worth Rs. 100, and you have a share of company ABC worth Rs. 10. Currently the weight of ABC in the overall portfolio is 10% (10/100).
Rule 5. Sometimes, shares of a company fall due to strong reasons. People who have invested in such shares should sell the stock immediately to minimise the losses. However, some investors start accumulating it further. These is investors are not willing to accept the fact that they made a wrong decision of buying that stock. The result is that they end up holding a laggard stock.

These are some of the rules that will help you make the right judgement. However, one single rule may not apply to all stocks at all times. The decision should be taken in entirety.
The bottom line is any sale that results in a gain is a good sale. When a sale results in a loss, and is accompanied by an understanding of why the loss occurred, it too may be considered a good sale. Selling is bad when it is dictated by emotion instead of data and analysis. Remember not to judge your selling by whether or not you are selling at the top. Instead focus on selling for reasons dictated by rational reasons of valuations and price.