The art of selling losing positions

Loss percentage Percentage rises to break even
10% 11%
15% 18%
20% 25%
25% 33%
30% 43%
35% 54%
40% 67%
45% 82%
50% 100%

A stock that drops 50% has to rise 100% to break even! In USD: A stock that drops 50% from $10 to $5 ($5/$10 = 50%) must rise $5 or 100% ($5 ÷ $5 = 100%) to get back to the original 10 USD purchase price. Many investors forget simple math and take bigger losses than they realize. They mistakenly believe that if a stock falls 20%, it only needs to rise by the same percentage to break even.

That’s not to say a rally will never happen. Sometimes a stock gets hit unfairly. But the long turnaround waiting period (about three to five years) also means that the stock is tying up funds that could be put into another stock with more potential. Always consider future potential. There is nothing you can do about the past, so stop clinging to it!

The best offense is a good defense

Championship teams have one thing in common: good defense. This principle also applies to the stock market. You cannot win unless you have a predetermined defensive strategy against excessive losses. We say “predetermined” because before or when you buy, you can think most clearly about why you’re selling. You don’t have an emotional attachment until you buy anything, so it’s likely a rational decision. Once we have something, we tend to let emotions like greed or fear take over and prevent us from making good judgments.

An adaptable sales strategy

The classic axiom of investing in stocks is to find quality companies at the right price. Following this principle makes it easy to see why there are no simple rules for buying and selling; it rarely boils down to something as simple as a price change. Investors must also consider the characteristics of the company itself. There are also many different types of investors, such as value or growth in terms of fundamental analysis.

READ ALSO:   The Basics of Trading Stocks: Know Your Orders

A sales strategy that works for one person may not work for someone else. Think of a short-term trader who places a stop-loss order for a 3% drop; this is a good strategy to limit any major losses. Stop-loss strategies can also be used by long-term traders, such as investors with a three- to five-year investment horizon. However, the drop percentage will be much higher than what short-term traders use, such as 15%. On the other hand, this stop-loss strategy becomes less and less useful as the investment time frame increases.

Questions to Ask Before Selling

If you know your investing style and have some ideas in your investment, use this framework to help you consider whether to sell. Start by asking yourself these questions:

  1. Why are you buying stocks?
  2. What has changed?
  3. Does this change affect your reasons for investing in the company?

The first question will be a simple one. Did you buy a company because of a strong balance sheet? Are they developing a new technology that will one day take the market by storm? Whatever the reason, this leads to a second question. Has your reason for buying this company changed?

If stock prices fall, there is usually a reason. The quality you liked in the company is still there, or has the company changed? It’s important not to limit your research to the original reason for the purchase. Check out all the latest headlines related to the company as well as any of its Securities and Exchange Commission (SEC) filings that might undercut the reasons behind the investment. If after some research you find the same quality as before, keep it in stock.

READ ALSO:   Financial planner and financial consultant: what is the difference?

If you’ve determined that a change has occurred, move on to the third question: Are the materials that changed enough to keep you from buying the company? For example, will it change the company’s business model? If so, you’d better offload the company because its business plan is very different from the reason you invested in it in the first place.

By remembering not to develop an emotional attachment to the company, your ability to make informed sales decisions will become easier and easier.

The Value Investor’s Sales Approach

Let’s demonstrate how value investors use this approach. Simply put, value investing is about acquiring quality companies at a discount. The strategy requires an extensive study of the company’s fundamentals.

1. Why do you buy stocks?

Suppose our value investor only buys companies with a price-to-earnings (P/E) ratio of 10% in the bottom 10% of the stock market, with earnings growing 10% annually.

2. What has changed?

Suppose the stock price falls 20%. Most investors cringe when they see so much of their hard-earned money evaporate. However, value investors sell stocks not just because prices have fallen, but because of a fundamental change in the characteristics that make stocks attractive.

Value investors know that research is needed to determine whether low P/E ratios and high yields still exist. Value investors will also look at other stock metrics to determine if the company is still worth investing in.

READ ALSO:   Reasons Why the VanEck Bitcoin ETF Is Still Hopeful

3. Does this change affect your reasons for investing in companies?

After investigating how or if a company has changed, our value investors will find that the company is going through one of two possible scenarios: It either still has a low P/E ratio and high earnings growth, or it no longer meets those criteria. If the company still meets the criteria for value investing, investors will stick with it. In fact, investors may actually buy more of the stock because it’s undervalued and sold at a discount.

In any other situation, such as a high price-to-earnings ratio and low earnings growth, investors might sell the stock, hoping to minimize losses. This approach works with any investment style. For example, growth investors will have different criteria when evaluating stocks. But the questions to be asked will remain the same.

bottom line

Note that we refer to this method as a guide. It requires your thought and work to ensure that these guidelines maximize the effectiveness of your investing style. All investors are different, so there are no hard selling rules that all investors should follow.

Even with these differences, all investors must have some sort of exit strategy. This would greatly increase the odds that investors won’t end up owning worthless stocks.

The point here is to think critically about sales. Know your investing style, then use this strategy to stay disciplined and keep your emotions out of the market.

Share your love