The problem with investors experiencing unprecedented price appreciation is that they are unable to control their greed. Their stock or portfolio may already be up 20%, 50% or even 100% but they still don’t want to sell because “I want more.”
Similarly, those already bleeding with losses due to price declines still don’t want to sell because they do not want to face the harsh reality that they have lost money. They continue to believe that the stock price will return to previous levels. This may be possible but, in some cases, the loss remains after several years because the price has not bounced back.
So when’s a good time to sell? After being invested in stocks for several years now, my experiences tell me that it is good to sell when the target profit has been met or an acceptable level of loss has been reached. Let me explain.
1. Target Price reached
Many traders and investors buy stocks with a predetermined target price. This value may be computed using valuation models such as the Dividend Discount Model, Free Cash Flow to Equity, Free Cash Flow to the Firm, or the Price Multiples Model, among others. Some, however, merely rely on rumored target prices or prices told to them by their brokers. Either way, lock in the profit by selling your stock upon reaching the target price.
In July 2010, for instance, I bought shares of Unionbank of the Philippines (UBP) at P45.50. My target price then was P60.00. Upon hitting the price, I unloaded the stock. It did rise further to P64.00 but I did not regret it. Now the stock is trading at P58.00. The key, I discovered, is in managing expectations and in managing greed.
2. Target Profit percentage met
In bull runs similar to what we saw in global markets in the middle of this year, stock prices break out then continue to rise indefinitely. For example, I bought Megaworld (MEG) shares at P1.26 back in May 2010. My target upside percentage then was only 41% (based on a Target Price of P1.78), but by November 2010, its price has reached P2.54, a price increase of 100%+. Honestly I was unable to control my greed after seeing the price breakout. Despite doubling my money and reaching the target price, I still wanted to hold on to the stock. But last week, stock prices began to tumble. That’s when it hit me: I should stick to my target profit percentage. I decided to sell MEG at a price of P2.40, locking in a 90% profit.
3. Cut your losses
When stock prices fall, investors usually overestimate the market by believing that prices will return to previous profitable levels. Sometimes they do in just a matter of days, but in most cases, it takes months or even years before prices bounce back. Investors are then stuck with a loss they don’t want to realize.
Save yourself from more misery by setting up a stop-loss order or by selling a stock when a target loss percentage is reached. For example, in September 2010, I bought AgriNurture Inc. (ANI) stock at P15.50. In recent weeks, prices have drastically fallen. At P12.50, my ANI shares have already lost 20% of the value. That’s when I decided to let go. Yes, it’s tough to sell at a loss and realize a 20% price reduction. But if I think prices will not return to past levels in the short run, I better cash out and transfer my money to another stock that could make me money.
I know someone who bought a stock right before the 1997 financial crisis. He decided to wait it out and still held on to that stock until today. Guess what? Only this year has the price returned to its pre-crisis level! That’s a long 13 years of waiting! That’s money that could have given him interest during the past 13 years had he invested it in, say, time deposit or bonds.
In summary, to profit in stocks, one should learn when to get out. Plan your exit strategy. If you’re winning, lock in the profit and don’t look back. Don’t regret if ever you sold a stock whose price still rose consistently. At least you already pocketed actual money.
When you’re losing, cut your losses and move on. Better to realize the loss now so you can transfer those funds to another stock that could possibly deliver you profits.