Selling is the dark art of investing.
Whether you’re watching CNBC, reading the financial news, or listening to your broker, you’ll hear about what you should buy. Buy this stock, buy that market, buy, buy, buy.
But you almost never hear about selling. Sure, when markets are falling, you hear theories about why other people are selling. But it’s a rare thing for someone to tell you “you should sell this stock” or “you should sell that market”.
Why don’t people talk more about selling an asset?
Selling doesn’t sizzle. There’s no thrill to it. Selling signals the end, rather than the beginning. Selling is sad.
This is daft, of course. You only make money on your investment when you sell. Until then, it’s all on paper. And if you don’t sell at the right time, or if you don’t know when to sell, those paper gains can turn into real losses.
Selling is the most important skill in investing. It’s also one of the least appreciated.
So here are five reasons to sell – to help you develop the underappreciated skill of selling.
1. You’ve hit your stop loss
A stop loss is a pre-determined level at which you’ll sell your shares.
The best type of stop loss is a trailing stop loss.
A trailing stop means that you sell your shares at a pre-determined level below the current market price. This price level is adjusted if the share price moves up. That way, you know exactly how much you stand to gain (or lose) as long as you sell at your trailing stop level.
Here’s an example of how it works: if you bought a stock at £2.00, you might set your trailing stop at 20% below that level, or £1.60. In this case, as long as you stick to your trailing stop, you’ll protect yourself against far greater losses.
On the other hand, let’s say that same stock climbs to £2.20. As the shares rise, you would continually adjust your trailing loss level to 20% below the market price. At £2.20, your sell level would be £1.76.
If the shares rose to £3.00, your trailing stop would stand at £2.40.
If you own shares, you need to have in mind a stop loss for every stock you own. Just as important, if a stock you hold hits your stop loss level, sell. Don’t second-guess your stop loss, because it’s almost guaranteed you will end up taking bigger losses over time.
And you can’t make money investing if you don’t have any money left to invest.
2. The reason you bought is no longer valid
Even if a stock hasn’t hit your stop loss level, you should sell it when the investment thesis has changed for the worse… that is, if the rationale behind your purchase no longer holds.
Companies change direction all the time – an expansion plan doesn’t work, a growth strategy falls flat, a new product doesn’t sell. If these things happen, it’s time to re-evaluate your investment. You need to step back and decide if you want to stick around for the new approach. If not, it’s time to move on.
3. You want to hedge
When markets are falling and you want to limit your downside, cash is the best hedge.
You see, in the short term – today, tomorrow, next month, next year – the value of your cash remains more or less constant, no matter what is happening in the markets. (Except if you’re in 1940s Germany, or recent-day Zimbabwe, or present-day Venezuela… but those are the rare exceptions.)
And sometimes, staying still – that is, not losing money – is enough.
4. You no longer want to “hold” (or: buy)
It’s easy to forget that when you own an asset (whether it’s a stock or a house or a Rolex) you’re actually buying it, every day.
You see, everything you own is taking up capital – actual cash. If that cash wasn’t being used for that item, it could be available to buy something else. So, by holding a position, you’re really “buying” that position each and every day that it’s in your portfolio.
So think of what you own, all of your assets, and ask yourself: “If I had the cash in my hand to buy this right now, instead of the thing itself (whether it’s a stock, a bond, a house, or a car), would I still buy it today?”
The point is, every day that you’re allocating capital to something, you’re actually “buying” it… and every day, you should be questioning whether that asset is worth buying (or, continuing to hold… and continuing to use your capital). Always consider if the potential returns to be made from holding is equal or higher to an alternative investment given the risks associated with owning it.
If it’s not, sell it.
5. You want to be ready in case you see money lying in the corner
Legendary investor Jim Rogers has said, “The way of the successful investor is normally to do nothing – not until you see money lying there, somewhere over in the corner, and all that is left for you to do is go over and pick it up.”
This means that when you see a clear roadmap to a cheap asset rising in price, you want to make sure you have the cash to buy. Selling gives you the chance to invest in these opportunities.
In short, when you buy an asset, you probably don’t know exactly when you’re going to sell (and in fact, you probably shouldn’t). It’s not going to be a date on the calendar, circled in red one day in the future. But the day you buy something, you should know what your criteria will be for selling – and be ready to sell when those criteria are met.
All the best,
Nathan Tipping
Research Analyst, Southbank Investment Research
Category: Market updates