When to Sell a Stock

When to Sell a Stock

(Source: photocase.com / Photographer: .marqs)

Do you have a sell list?

A sell list is a little piece of research you write down before you buy a stock that lists all the reasons you might want to sell it in the future.  You want to have one.  Here’s why.

Humans are notoriously bad at prediction. Just like going to the supermarket on an empty stomach, then wondering why you bought so many superfluous items, our present emotional state has an inordinate amount of say in our predictions.  If we have to make predictions we want to do so with as clear a mind as possible.

The time spent researching whether to buy a stock is the best time to force yourself to invert and ask why might you want to sell the stock. Before you buy, start brainstorming every negative possibility that would make you want to sell the stock if you owned it.  This will pour a bit of rational cold water on an overactive mind and help you overcome any emotional biases your brain has decided to latch on to.

Reasons to Sell a Stock

Morningstar has a really great set of four reasons to sell a stock:

  1. You made a mistake in your research.
  2. The stock is wildly overvalued.
  3. The business fundamentals are deteriorating.
  4. You need the money for a specific purpose. (Home repair, medical expenses, etc…)

Working from these guidelines and your brainstorming session, write up a list of reasons why you may want to sell the stock in the future, such as:

  • The stock trades for a 50% premium over intrinsic value.
  • A competitor has eroded the firm’s economic moat and market share has dropped below a specified percentage.
  • Profit margins have deteriorated below a certain level.  Be specific.  Build in set quantitative thresholds.

Though not specifically listed in Morningstar’s list, I often add selling if I think management is guilty of lying, cheating, or stealing.  The website Footnoted is a great way to learn how to read financial statements and assess management’s trustworthiness before their transgressions are reflected in the stock price.

Stick to Your Plan

Once you have your sell reasons, you can update them, but try to do so at specified intervals on your calendar and not when you are actually considering selling.  You want to follow the rules you set for yourself when your mind was unbiased.  If you find yourself in shock that your beloved security has suddenly dropped 10% in value in a day, first consult your sell reasons and try to asses if your thesis is intact.  If so, maybe you’re seeing an opportunity to buy more.  Planning ahead allows you to outsmart Mr. Market, not be at the mercy of his and your emotions.