The vast majority of investment advice is geared towards buying. This should come as no surprise to investors since it’s the buying of securities that begins the entire investment process. It’s also the buying that generates commissions and fees for brokers. Of course what is bought must be sold, and each trade exacts commissions and fees. In this article, we’ll look at the art of selling a stock.
The Importance of SellingBuying at the right price is vital. The ultimate return one will gain on any investment is first determined by the buy price. In a way, one can argue that a profit or loss is made upon buying; you just don’t know it until you sell. While this theory is deeply rooted in sound fundamental principles of investing, selling is also a vital link. Indeed, while buying at the right price may ultimately determine the profit gained, selling at the right price guarantees the actual profit, if any. If you can’t sell at the appropriate time, the benefits of proper buying disappear. (Just starting out? Check out our Stock Basics Tutorial.)
The Casino Trade: Why Selling Is So HardThe reason why many have trouble selling is rooted in an innate human tendency to be greedy. For example, an investor purchases shares of stock at $25 a share, and tells herself that if the stock hits $30, she will sell. What happens next is all too common. The stock hits $30 and the investor decides to hold out for a couple of more points. Surely, the stock reaches $32 and greed continues overcome rationality. She holds out for more. Suddenly the stock price takes a turn downward and is back at $29. The investor then tells herself that once the stock hits $30 again, she will sell it all. Unfortunately, this never happens and the stock price continues to drift lower. Succumbing to her emotions and frustrations, the investors sells at $23, below her initial buy price.
As greed and emotion overcame rational judgment in this scenario, sound investment principles were replaced by casino-like tendencies. The initial result was a loss. And while the investment loss was $2 a share, the true loss was $7 because the investor had the opportunity to sell at $30, but refused. Sometimes these types of paper losses are better ignored than agonized over, but it all comes down to the reason an investor chooses to or not to sell. A sound selling decision that leaves some profit on the table may look exactly like a poor selling decision leaving the same amount, but the process by which an investor comes to the decision is critical.
So knowing when to sell is of paramount importance. From the example above, proper selling reduces the likelihood suffering two ultimate consequences. In the first instance, proper selling helps ensure the preservation of gains. In the second instance, proper selling reduces the likelihood of incurring major losses.