It’s easy to buy a stock. I’m not talking about the mechanics, although that’s pretty easy, too, but rather the decision to buy a stock. It can be as simple as “I really like (shopping/eating/some other form of consumption) here. Others probably do, too. I should buy some stock.”
Certainly, not all investment buying decisions are made that quickly, but even with the most elaborate pricing model or decision matrix, the decision to buy is much easier than deciding when to sell.
The process of deciding when to sell a stock opens a Pandora’s box of behavioral biases that can cause a poor decision, including, as the band Rush put it, “If you choose not to decide you still have made a choice.”
So, how do some investors reach their sell decision? Some sell decisions are more or less forced on an investor – they have need for the funds or it’s time to rebalance the portfolio.
If your hand is not forced, though, some of the most popular reasons to sell, in no particular order, are:
Target price – Especially popular with traders, some people will make a purchase with a target price in mind. Once the stock hits that level, they sell. This method involves the most legwork up front and can cause the sale to happen too early, missing out on additional returns.
Valuation – Some investors will sell when a company seems to be overvalued compared to its peers or historical average, usually based on a fundamental ratio like the Price/Earnings (PE) ratio. This, too, can cause an investor to miss additional returns as a company may have additional factors involved “justifying” an increased valuation.
Changing Thesis – In some cases, the reason you invested in the first place may no longer be viable. Perhaps their new product bombed, their patents expired, or a new competitor is taking market share. It’s important to avoid cognitive dissonance and honestly examine if the original investment thesis still holds water.
Legal Issues – If you see the words “SEC investigation over accounting practices…” in a story about a company, sell the stock and run.
Gut Feelings – This, unfortunately, is where most sell decisions ultimately happen. This is where decisions based on price movement – either up or down – fall. Where behavioral financial biases exert undue pressure. Where emotions wreak havoc on your investment portfolio. This is where a good financial advisor can help you navigate the investment minefield.
Ultimately sales will – and should! – happen occasionally. By making sales in a measured, thoughtful way and avoiding the “Gut Feeling” category, you can increase your chances of success.
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