These 5 Tips Will Help You Choose the Best Time to Sell Your Stocks

When it comes to investing, sometimes it can be easier to decide when to buy a stock than to decide when to sell it.

Buy recommendations are widespread and come from a variety of sources, including investment newsletters, analysts, stock brokers and investment managers. However, few people give detailed advice on when is the best time to sell stocks. Here are five tips for when it might be time to sell.

1. It hits your target price.

When initially purchasing a stock, astute investors set a price target, or at least a range in which they consider selling the stock. Every stock purchase should also include an analysis of its value, and ideally the current price should be at a significant discount to this estimated value. For example, selling a stock when its price has doubled is a worthy goal and implies that the investor believes it is 50% undervalued.

It is difficult for even the most experienced investor to determine a single target price. Instead, a range is more realistic, as is the decision to sell a position as it rises to lock in a profit.

2. Deterioration in fundamentals

Along with monitoring the firm’s share price once a price target has been set, monitoring the performance of the underlying business is important. The main reason for the sale is the deterioration of the business’s fundamentals. In an ideal world, an investor would recognize a deterioration in sales, earnings, cash flow, or other key operating metrics before the stock price begins to decline. More experienced analysts may read financial statements closely, for example, making footnotes that other investors are more likely to skip.

Fraud is one of the most serious fundamental flaws. Investors who spotted financial fraud early on from companies such as WorldCom, Enron, and Tyco were able to save significant sums as their stock prices plummeted.

3. A better opportunity comes along.

Opportunity cost is the potential benefits that an investor forgoes by choosing one alternative over another. Before you buy a stock, always compare it to the potential profits you could make by owning other stocks. If this option is better, then it makes sense to sell the current position and buy another.

Opportunity costs are extremely difficult to pinpoint, but may include investing in a competitor if it has equally attractive growth prospects and is trading at a lower valuation, such as a lower P/E ratio.

4. After the merger

The average takeover premium, or the price at which a company is bought out, typically ranges from 20 to 40%. If an investor is fortunate enough to own shares that end up being purchased at a significant premium, the best course of action may be to sell them. Continuing to hold shares after a merger may have its advantages, for example if the competitive position of the combined companies improves significantly.

However, mergers have a poor track record. In addition, completion of the transaction may take several months. Thus, from an opportunity cost perspective, it may make sense to find an alternative investment opportunity with better growth potential.

5. After bankruptcy

In the vast majority of cases, a bankrupt company becomes worthless to shareholders. However, for tax purposes, it is important to sell or realize losses so they can offset future capital gains and a small percentage of regular income each year.

Selling stocks immediately after bankruptcy often results in big losses, but you may still be able to get back a few cents on the dollar.

Bottom line

Deciding to sell a stock is truly a combination of art and science. When deciding whether a stock’s rally has run its course or is likely to continue, there are a number of considerations to take into account, such as the ones above. One common sense strategy is to sell as the stock rises to lock in profits over time, and sell as it loses to prevent it from getting out of hand.