To Sell or Not To Sell? A Perennial Dilemma!

To Sell or Not To Sell? A Perennial Dilemma!

Most investors are cognizant of John Bogle’s renowned saying, ‘Buy right and hold tight.’ In the journey of compounding money over the long horizon, time is indeed your best friend. But, what comes after you have held on to your investments for a long period of time? What about ‘selling right’?

 

Buying at the right price and holding on to it decides the amount of notional profit an investor has captured. But, it is only by selling at the right price that an investor is able to recognise profits. If an investor fails to sell at the right time and price, the advantage accrued by buying right and holding tight simply vanishes. With frontline indices constantly recording new highs and the markets unwilling to pivot their upward trajectory over the past few months, a common conundrum floating through the minds of all investors is: should I sell and book profits or should I wait a little longer?

Umpteen investors face trouble when deciding to selling stocks. It’s not completely systematic and one has to acknowledge the wide range of emotions like greed, regret or plain ‘fear of missing out’ (FOMO) at play. There are many investors who hold on to their stocks for a very long period of time in the hope that by doing so the returns would turn out to be astounding. Imaging buying 100 stocks of a company at Rs 100 per share and then waiting for a good number of years till the price touches Rs 200 per share. That’s 100 per cent profit. But is the wait worth it? So yes, selling a stock is more difficult than buying a stock. Let’s identify a few good reasons to sell a stock:

Profit Booking

There is good chance that a stock you recently invested in has shot up significantly in a short timeframe. Don’t let this success set foot into your head and get the better of you. Keep in mind that a particular company’s stock price can soar massively in the short term for a diverse variety of reasons. It could be speculation by others, positive news, analyst upgrades, broad-based demand in the market and what not. An investor must be smart and take some money off the table. Be mindful of the age old saying ‘No one goes broke booking a profit.’ If the stock price drops substantially later on, you can always enter again.

Failed Investment Hypothesis

This is when a company’s performance over the years fails to match the investor’s expectations, thereby deviating from the investment hypothesis established while making the investment. It could also be that the investor has made a mistake by overlooking certain aspects of the business, hence making it an unsuitable investment for him or her. Other instances could be industry headwinds, changing business fundamentals, deteriorating financials, shrinking market share, strong competition from peers, diminishing competitive advantage or genuine lack of confidence in management. All these represent valid and rational reasons to sell a stock.

Lack of Valuation Comfort

Valuation of a stock exhibits a relatively tricky and sensitive basis on which to sell a stock. Warren Buffett has rightly said, “Valuing a business is part art and part science.” The value of a stock is the present value of its future cash flows. However, forecasting future cash flows of a company is subjective and differs from investor to investor. There are simple practices that can be used to spot overvalued stocks. If a stock’s PE ratio significantly exceeds its average PE ratio over the past 5-10 years or if the stock’s PE ratio is substantially higher than that of its peers, an investor will exit the stock.

Rebalancing and Diversifying

Investors who follow a pre-determined asset allocation approach are obligated to review their entire investment portfolio at least once a year and rebalance as per their target asset allocation. For example, if stocks have witnessed a solid rally during a given year, thereby increasing the overall weightage of equities in a portfolio, an investor might book some profits and rebalance the portfolio. Also, change in an investor’s circumstances like having children or retirement will alter the investor’s financial goals, risk profile and result in diversification towards less risky asset classes.

The above are several paramount reasons that could lead to the terminal decision of selling a stock. But, truth be told, selling a stock is easier said than done. Selling manifests a dilemma. What if you exit a stock and it suddenly spirals upward the very next day? Innate human emotions like fear and greed often compel investors to rethink their decision to sell. The question remains: how to get better at selling your stocks? A decision to sell should be based on analysis and not emotions. Here are some basic tactics that can help disregard emotions and induct discipline in the selling process.

Don’t Sell All At Once

Irrespective of whether you are booking profits or cutting losses, never sell it all at once. It is a futile exercise to speculate the peak price of a stock. Uncertainty is the only certainty; therefore one should sell their stocks in tranches. The rupee or dollar cost averaging is fundamental not only while buying stocks but also while selling them. In this manner, you may not get to exit at the zenith, but you also won’t be selling all your holdings at one price. Following this approach curtails the influence of emotions that comes with stock price fluctuations and ensures that investors don’t second guess their decision to sell. Investors can also implement incremental selling by making use of a trailing stop loss order. The trailing stop loss can either be a percentage, say 5 per cent or a fixed amount. It gets triggered the moment a stock reaches that particular price and instantly places a sell order.

Avoid Loss Aversion

Loss aversion is a behavioural economics phenomenon, which states that experiencing a loss is psychologically or emotionally more powerful than recognising gains. For instance, the pain of losing Rs 1,000 is often much greater than the joy gaining the same amount. Hence, we always prefer to sense victory over a sense of regret. Investors frequently choose to sell their outperforming stocks and hold on to the losers or underperforming stocks in the hopes that they will get an opportunity to exit at a breakeven price without booking losses. Peter Lynch precisely describes it thus: ‘Selling your winners and holding your losers is like cutting the flowers and watering the weeds.

Candidly speaking, not all stocks are going to be winners.


Unwillingness to sell a stock because the current price is below your buying price is a classic psychological trap. Oftentimes it is difficult to recognise and accept one’s mistake, but one must do it. An investor’s ego and arrogance can ravage his or her overall portfolio returns. Booking losses can be a bitter pill to swallow in the present, but on the contrary there is a good chance that exiting at a 20 per cent or 30 per cent loss could later transpire to be one of the smartest investment decisions ever made. All investors make mistakes, but only wise investors learn from their mistakes.

Follow Asset Allocation

Bear and bull markets impair an investor’s decision-making ability and sway them to omit their asset allocation. But investors who religiously follow their target asset allocation, irrespective of market conditions, will find it easy to sell stocks while rebalancing their overall investments.

 

Rate this article:
No rating
Comments are only visible to subscribers.

DALAL STREET INVESTMENT JOURNAL - DEMOCRATIZING WEALTH CREATION

Principal Officer: Mr. Shashikant Singh,
Email: principalofficer@dsij.in
Tel: (+91)-20-66663800

Compliance Officer: Mr. Rajesh Padode
Email: complianceofficer@dsij.in
Tel: (+91)-20-66663800

Grievance Officer: Mr. Rajesh Padode
Email: service@dsij.in
Tel: (+91)-20-66663800

Corresponding SEBI regional/local office address- SEBI Bhavan BKC, Plot No.C4-A, 'G' Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400051, Maharashtra.
Tel: +91-22-26449000 / 40459000 | Fax : +91-22-26449019-22 / 40459019-22 | E-mail : sebi@sebi.gov.in | Toll Free Investor Helpline: 1800 22 7575 | SEBI SCORES | SMARTODR