Investing in and trading stocks is not just about making a profit. It is about controlling your losses as well. Managing risk, preserving trading and investing capital, and taking losses right away are all important skills to learn in the stock market. How you handle this will be somewhat different depending on if you are trading stocks over the short term or investing for the long term. In one case when to sell a stock can be a matter of simple arithmetic. Or it may be a matter of understanding fundamentals and stock intrinsic value.
When to Take a Loss When Trading Stocks
When you are day trading you are looking to gain profits from the ups and downs of the market. This is especially true with a strategy like scalping. When you are trading a persistent upward trend it may be different. In the case of long term stock investing, you have chosen a company that you believe will continue to make money into the distant future. In this case you may be seeing a good investment show a short term loss due to factors that are affecting the entire market. A common approach in short term trading is to choose a fixed percentage like 6, 7, or 8 percent at which you will routinely sell to prevent greater losses.
Normal Daily Stock Fluctuations
Because there are predictable daily stock fluctuations it is important not to bail out of a profitable trading or investing opportunity when the stock falls a percent or two. One or even 2% up or down is not uncommon for a stock. 1% up or down happens to the average stock two out of three trading days. Fluctuations of 2% happen one trading day out of five. One trading day out of 10 one can expect to see as much as a 3% move up or down.
Why Is a Stock Price Falling or Rising?
There are two ways to help predict stock prices. One is assessment of stock fundamentals and the other is technical analysis of market sentiment. To the extent that you clearly understand what is going on in the market, you can often let the market fall a bit. To the extent that you have no idea what is going on you would need to have a plan in place. That plan will typically be that you automatically sell when a stock has fallen 6% or more. An event like a short squeeze can frequently take a stock up and then dramatically down within a day or two.
Dollar Cost Averaging and (Almost Never) Selling a Stock
There are so-called widow and orphan stocks. These are companies that have been extremely stable and profitable for decades or even more than a century. A common approach with this kind of stock is to use dollar cost averaging. In this case an investor invests a fixed sum of money in the stock every month, quarter, or year. The assumption is that this stock will continue to pay dividends and rise in value year after year after year. By investing a fixed dollar amount the investor is buying fewer shares when the price is high and buying more shares when the price is low. With this approach the investor sees their investment grow year after year. That having been said there are times, such as with Eastman Kodak, when the company’s business plan no longer works. What is important in such a situation is to look at this investment from time to time. If this is no longer a stock that you would invest in new today then you need to get out and cut your losses no matter what percent the stock price has fallen.
SlideShare Version – When to Sell a Stock