There may be reasons to want to sell or even have to sell shares. But you should know a few things about when to sell stocks and how to decide to sell them. In the following article, I will take a closer look at the individual reasons and show you why you should sell your shares less often than you might think.
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What happens when you sell stocks
Before we go into detail, there are a few things you should understand.
Know the consequences
The sale of your shares has several consequences. First, you are no longer the co-owner of the company. You lose all the rights you had before. For example, you will no longer receive dividends. You may also have to pay taxes and fees to your broker.
Where someone sells, someone buys
If you want to sell shares, it still means that you have to find a buyer. Nowadays, all this is done by a broker, and it is easy to sell your shares. But remember that this one buyer has an interest in buying your shares. So if you think you’re selling a loser that won’t perform, another market participant seems to think just the opposite.
Who is right? Of course, you don’t know that until later. But everything has two perspectives, and you should try to put yourself in the position of a potential buyer to find out why a sale might not be a good idea after all.
“Trading back and forth empties your pockets.”
Years of studies prove the fact that most returns are lower when using a strategy that tries to time the market.
In a study, Kim Johnson and Tom Krueger examined the precise effects of such strategies on the S&P 500 for two decades (1982 – 2001) and revealed some interesting facts.
Those who had only traded the best days on the stock exchanges could achieve tremendous results. But and that is the decisive point, if you had missed the 50 best performing days in the more than 7000 days in these 20 years, your return would have been just above inflation.
Of course, theoretically, investors get the highest returns if they miss the bad days and only get the best days. And sometimes investors also manage to perform better than the market as a whole (but don’t get fooled).
But over the long term, it is impossible to predict the exact course of the stock markets. It is, therefore, possible that investors will miss the best days, and then their returns will be quite poor. In most cases, such investors then perform worse than the broader market.
One mistake that many investors make is to only look at the possible return. However, the fact that a profit is theoretically possible does not mean that it is realistic to achieve.
So when you sell your stock, ask yourself why you are doing this. If you sell because you think in the short term that the share will fall or another stock will rise, then it is better not to play such games. Experience shows that you will not be successful.
Don’t sell in a panic!
The worst advice on the stock markets is your gut feeling. Don’t listen to your feelings! Conduct sober due diligence and stick to the result of this assessment. The intrinsic value of a company does not change with the level of its share price. A farmer does not sell his farm just because it was a bad harvest year, and his income has fallen.
The stock markets are incredibly volatile, and you should not attach too much weight to the ups and downs. Did you know that the biggest and most successful companies in history since their IPO even had days when they lost more than 30 or 40 percent of their value? If you had sold here in a panic, it would have cost you your well-deserved retirement in prosperity! Take Apple as an example. From the IPO until now (May 2020), Apple’s share price gained 57,860 percent in value! And Apple has also crashed badly several times:
There will always phases in which you will suffer severe book losses. The shares of these four companies have crashed badly at least once. Apple, for example, lost 50 percent of its value in one day. On a day like this, you don’t have time to react. You just have to sit it out, close your eyes and move on. It’s better to stay in the valley a while longer than to miss the summit.
Know your exit strategy before you invest in stocks
It is also essential that you decide at the same time as buying a share under which circumstances you will sell the share again. This is closely related to your investment strategy and wealth management. Are you more of a buy-and-hold type of investor or more of a stock picker using other criteria such as trends or fundamental valuations? What is important here is that you have a strategy and that you follow this strategy. This will help you to act rationally and not become emotional (see above).
The Only True Reasons to Sell Stocks
So you see. There are not so many reasons for a sale. This is especially true if you have a long-term investment approach and want to keep your capital working for you for a long time. Nevertheless, there are valid reasons to consider selling a share.
You need money within the next few years
Imagine if you had invested in a stock like Amazon years or even decades ago. Your shares would have quickly increased in value by 1,000 percent or more. You have endured the interim price volatility and are now sitting on a considerable book profit. Besides, you may want to make a more substantial investment over the next few years. You might want to buy a house or retire early. Life is finite, and there is no point in taking a massive chunk of money to the grave. Such cases are typical reasons why a sale can make sense.
Your investment thesis is no longer intact
Another reasonable reason for a sale may be that your investment thesis is no longer intact. Mainly when investors invest in several companies over the long term, it can happen quite frequently that companies change their business model or dividend policy.
Another example would be mergers that completely change the character of a company. You must feel comfortable with your investments. If you analyze rationally and find that a company no longer has a future in fundamental terms and no longer meets your initial investment criteria, there is no reason why you should not sell shares. Nevertheless, you should consider the above aspects. Someone will buy your shares, who may have come to a different conclusion with his analysis.
No real reasons
Other reasons that may justify a sale are often mentioned as well. I see them ambivalent. The following three main considerations play a role here:
- Awful stock price performance
- Selling because of a (coming) stock market crash
So let us take a closer look at these reasons in the following:
Stocks are often sold because they perform poorly and stagnate in value for a long time. To sell for these reasons would be wrong. And why is that? With this perspective, you only look at the value of your stock, but you have to analyze the value of the company.
Otherwise, it might be that you sell a part of your company for less than its intrinsic value. Microsoft is a good example. For years the share price has stagnated. Many investors were disappointed and saw in Microsoft, a dying giant. All it took was a change in management to fully develop the value of the company and drive the share price to entirely new heights. After stagnating for almost 15 years, the share value has more than tripled within the past five years.
Therefore, you should not base a sale on the development of the share price, but on the fundamental prospects of the company. Does its business have a future, does it have potential, or is it stumbling towards its demise? If the latter is the case, however, we have returned to the question of an investment thesis that is no longer valid (see above).
Should I sell all my stocks in a stock market crash?
Other investors tend to sell when the stock markets collapse, the company has a bad year, and the mood is generally rather bad. They then say that this is only the beginning, and it will only get worse. They want to sell the shares quickly so that they can repurchase them later, even cheaper. Indeed, stocks that have once lost 50 percent can lose another 50 percent. In this respect, there is always further downside potential. But do you know if it goes up or if it goes down even further?
The answer to this is simple. You just don’t know. Market timing is not possible (see also above). But one thing is relatively certain. In the long term, the stock markets will rise again. That has always been the case and it is very likely that it will be the case again.
There is also the possibility to sell shares when they are fundamentally highly valued. To determine the perfect moment, many investors use valuation criteria such as the Price/Earnings ratio, Price/Book Value ratio, Price/Free Cash Flow ratio, or other multiples. The idea behind this is that stock prices tend to return to their average.
Overvaluations have often resulted in significant price setbacks and corrections
In retrospect, overvaluations have therefore often resulted in significant price setbacks and corrections. Therefore, it seems a good idea to sell stocks when they are overvalued and buy them back later. However, the strategy has some weak spots that make it not really recommendable. Here we should go into some detail.
The first is that you are not the only one who notices a comparatively high valuation of a stock. Thousands of analysts have long since become aware of this through algorithms. Yet all these investors are not selling. Are they misjudging the situation or have they become too greedy? If the share price is still at a high level, then it may, of course, be that all these professionals are wrong and only you understand what the right value of the company is and why it is now much too high.
Who says that an overvaluation leads to a price correction or even a crash?
Be honest! How likely is it that everyone else is wrong but you? You should also bear in mind that you may be basing a sales decision on a false causality. Who says that an overvaluation leads to a price correction or even a crash? There are many aspects that could be relevant here.
One possibility is that the company is currently undergoing operational changes and a higher valuation is simply the right consequence. This could be the case, for example, if growth stagnated for a long time and then suddenly exploded. In addition, overvaluations can also dissolve into a sideways trend. Afterward, the price rises again. So you have sold your shares, waited for falling prices, and are still waiting. Classic newbie mistake…
Just as important is the fact that you can never determine when a stock is facing a correction or a decline in price. A company can be overvalued and yet the price can continue to rise for years. Even if there is a correction, it may never fall back to the price you sold with. In this respect, investors tend to take their profits too early. This behavior is typical for investors and a classic cognitive bias. In behavioral research, there is even a name for this. This theory is called prospect theory and says that people subjectively weight the initial profit more than the ongoing profit and therefore sell faster to realize the book profit.
Church & Dwight
An example of how difficult such a strategy can be is Church & Dwight. The share had been overvalued since 2013. Those who sold because of the overvaluation had few opportunities to get back into the share in the course of a correction.
When to sell stocks and how to decide to sell can be two tough questions. As always, there is no right or wrong. However, most reasons to sell stocks turn out to be a simple attempt to time the market. Experience has shown that this does not work in most cases. So it is a bet with bad odds for you!
A good recommendation is therefore simply to diversify widely and take a long-term approach. With ETF’s you will achieve a super average return that will outperform all other asset classes in the long run and let you sleep well. So don’t keep asking yourself whether you should sell. Instead, let your portfolio work for you and enjoy your life, you have deserved it! And if it does come to a crash, here’s something for your nerves.