It is often said that the timing of buying and selling a stock are key decisions in making a profit from your investment.
Some experts would argue that the profit or loss is made on an investment when a stock is purchased; it is just that the buyer doesn't know it until its sold. However, the two are correlated because if you don't sell at the right time, not much is gained from buying at the right price.
Knowing when is the right time to sell is finding a balance between greed and fear. Using a strategy, you may be able to keep the human emotions out of the decision making process.
1. Price has gone up too much too fast
When the price of a stock you already hold goes up too soon too fast, you may want to book your profits and move on.
There are instances when stock prices move up in a short period of time for a number of reasons including speculation, low liquidity. These are the ones that often make the headlines but when a cheap stock becomes expensive too fast, it is unlikely to sustain the high level.
Even if it is a quality stock, you can book profits and consider buying it again at lower price levels later.
2. If buying the stock was a mistake
As part of the fundamental analysis technique of picking stocks, it is important to know why you bought the stock.
Ace investors always do their homework on the company's operating performance, the top management confidence in the growth of the company and business environment.
If the rationale behind buying the stock does not apply after a regulatory change or a permanent change in the business environment, you may want to consider selling the stock.
If the rationale behind buying the stock was flawed from the beginning or you realise that you have made a mistake, you should sell before you lose money as well as the opportunity cost of not investing in a different company.
Note for signs of weakness in the business model, if the company's earnings were lower than expected in quarterly/annual results, or if the company is losing market share to competitors.
Don't feel bad if the stock goes up after you sell because you have made an analytical decision.
3. The stock price has reached unsustainable levels
Ideally, investors are advised to book profits on a stock when the company's valuation is significantly higher than its peers.
The value of a share of the stock rests on the present value of the company's future cash flows, which cannot be precise since the future is uncertain. Analysts use the price-to-earnings ratio (P/E ratio) for valuing a company and making comparisons with peers. The ratio can also be used to compare a company against its own historical record.
It is an indicator of whether a stock is overpriced, underpriced or fairly priced, helping investors decide if its time to buy or sell.
There are also industry-specific benchmark PE ratios that are used to gauge the share price of the stock.
A very high PE ratio is when the price of a share is higher than earnings per share (EPS), which means that the shares are overpriced and will most likely see a correction in the future. It would be right to book your profits when the shares are overpriced.
4. When you need money
What good are assets if you cannot encash them when you need them? If you are in need of cash or if you have met your financial goals with the stock investment, you could exit irrespective of where the stock fundamentals stand.
Tip: Place a limit order on your stock investments. The above strategies require you to keep an eye on the movement of prices which is not realistic if you are not a professional trader. By placing a limit order your broker will automatically sell a stock when it reaches the target price.
You will receive a notification when the sell order is placed.