How to Form a Selling Strategy
Most investors think a lot about what to buy, when to buy, how much to buy, and how much to pay. Whether they use a value investing strategy or are more trading-oriented, most of the focus on investing comes before shares are ever bought.
But that’s only half of investing. The other half? Knowing when to sell.
As with buying, there’s no one set answer. It will likely come down to your personal risk tolerance, asset allocation, financial goals, and investment strategy.
It may also include factors such as whether or not you’re trading penny stocks, or if you have to hold company shares in an Employee Stock Purchase Plan (ESPP), the kinds of trades that have very different holding periods.
If you’re holding an index fund, mutual fund, or ETF, changes within that fund are done automatically for you, meaning you don’t have to sell there. But with individual stocks? It’s different.
So let’s look at the top reasons to hold onto an individual stock—whether you’re a long-term buyer or more of a trader—and reasons why you may want to sell your shares, even if it means taking a loss.
When to Hold a Stock
Reason 1: The Company is Expanding
A company that’s growing its operations will likely see its share price move higher as well. That may not be true on a day-to-day basis, much to the chagrin of day traders, but over time that holds up. Higher sales equates to higher revenues, which equates to higher earnings per share. As earnings grow, a share price tends to rise as well. That can result in a long holding period, but one that leads to massive gains.
It can even rise ahead of profitability, as many early-stage companies that have gone public, particularly in the tech space, have shown. Their shares also tend to rise as institutional investors such as hedge funds pile in.
In the case of an expanding company, an investor may only want to consider selling if that growth starts to show signs of slowing down, as the company reaches customer saturation. Or, a sale would make sense only if the capital was needed to invest in an even-faster growing company and there isn’t room in the portfolio for both names. But buyer beware: Taking profits off the table in a growth name may mean a hefty tax bill.
Reason 2: The Company has a New Product Launch
All companies have products and services whose demand ebbs and flows over time. A tax preparer may be busy in the first half of the year, but not in the second half. The term “black Friday” originated in retail as the day after Thanksgiving was typically the first day of the year that retail operations started to make money for the year.
In a tech company, there’s usually a short product lifecycle. From software to computer chips, these products tend to get developed, launched, reach market saturation, and see new competition come up in a short span of time. Many big tech names that have been great performers have seen this short lifecycle and helped keep it short by coming up with better versions of computer chips, graphics processors, software, apps, and so on.
Reason 3: The Company is Maintaining or Growing a Dividend
Shifting a bit from stock traders looking a few days to a few months out to long-term investors, the key reason to hold shares of a company after growth are that it pays a dividend. More importantly, value investors want to look for dividend stocks, or companies that tend to increase their total dividend payout annually like clockwork.
Why? Because rising dividends are a sign that a company has steady, consistent, and slightly growing cash flows. And that the company is mature enough that it doesn’t need all that cash flow for further internal growth, thanks to a strong balance sheet. This is where smart investors go to find quality stocks that can avoid the worst of market volatility and provide growth while also meeting their risk tolerance.
For long-term investors with an average holding period measured in years, dividend growth stocks are great for any long holding period. Unlike bonds, which pay a fixed income, growing dividends also tend to lead to higher share prices to keep dividend yields in line, so you get more money each year and a higher share price.
While the growth may not be as exciting as a tech play, over time it can create large amounts of wealth and increasing income every year without the need to make further investments. That’s a solid win, and a great reason to hold shares of a stock indefinitely.
When to Sell a Stock at a Loss
Reason 1: The Stock Hits a Stop Loss
This is a fairly simple reason to take a capital loss, especially while day trading.
Why? A core part of any trading strategy is to cut your losers short early and let your winners ride. Most traders use stop losses to ensure this happens, and they can also spot when that’s likely to happen based on the charts.
When you have a stop loss, you set a certain price point in advance where you’re willing to take a smaller loss before it becomes a larger one.
Remember, if a stock drops by half, it has to double before it even gets back to breakeven—so cutting losses short is an essential tool to stay invested, even if it means selling a stock at a loss.
How far should a stop loss be from an entry price? There’s no set number. Some traders use 10 percent, some use 7 percent, some may use smaller percentages if they’re trading with leverage. It depends on overall market volatility and the perceived volatility in the individual trade.
Anyone engaging in options trading may use a little more wiggle room, such as 20 percent, to avoid getting knocked out of a trade too quickly before it gets into trouble.
For traders with a position that’s rallied and is showing a gain, stop losses can be adjusted over time to a higher level. Once a position is up 5-10 percent, a trader may want to adjust their stop loss to their purchase price, so that on a pullback there’s no loss at all. This adjustment is known as a “trailing stop loss.”
Longer-term investors can use stop losses as well, which ensures that their long-term holdings don’t take too much of a hit in a bear market.
For instance, when the bull market ended and stocks tanked 30 percent in 2020, investors with stop losses could have avoided half the damage or more with a reasonable stop loss program in place. That would have left them capital to make new trades, or get back into shares at a lower price.
Reason 2: The Company is in Financial Trouble
Amidst all the excitement of trading, it’s easy to forget that a stock is just a fractional ownership of a business. And how that business operates can greatly impact its share price.
When a company runs into trouble, and nearly every company will at some point more than once, their stock price can take a dive. If a company has a bad quarter, that’s no big deal.
But if a company is starting to see a sustained decline in its core business, it becomes more important to look at how the company is responding to that issue—and hopefully moving into a new line of business that can grow rapidly.
Companies that are less flexible are likely to struggle for years, underperforming for shareholders and serving as market laggards. That’s been the case with General Electric, which was the worst performing stock in the Dow Jones Industrial Average for two years before being booted from that Index—the last of the original Dow components to go.
Reason 3: The Company is Changing Course
Companies can change course all the time. But there’s a difference between launching a new product that fits in with the company’s existing ecosystem and one that represents a radically new direction.
For instance, in late 2017 at the height of the Bitcoin bubble, a company called Long Island Iced Tea, manufacturer of beverages, announced that it was getting into the cryptocurrency space as well. The news was enough to briefly send shares spiking higher on the stock market. But it was also a sign of the Bitcoin bubble, and a chance for shareholders to take a quick profit before the bubble burst.
Bottom line, if the company you analyzed and bought shares of is no longer doing anything remotely close to what you originally determined, it may be best to make a sale, or at least start an analysis of what the new company will look like. In these cases, it’s usually best to cash out, even if it means a loss, to preserve your money.
Remember, all of the above reasons are valid ones to sell out of a stock and avoid a steep loss. That may include any company stock you own from your time with an employer as well, including vested shares from stock options.
Benefits of Holding a Stock for the Long-Term
Long-Term Benefit #1: Lower Tax Rates
For investors who hold shares of a company indefinitely, there are other advantages as well. For those that hold over a year, investors pay a lower tax rate known as the “long-term capital gains” tax. Anyone invested under a year, from traders in and out in a millisecond to those in a trade for 364 days are stuck with a higher rate under the “short-term capital gains” tax.
So in addition to sticking around with a company as it grows over the long-haul, and picking up cash dividends regularly like clockwork, there’s also a lower tax rate if you sell. The key word is “if.” There’s no requirement to ever sell your shares, particularly if you’re holding shares in a great, wealth-compounding company.
Long-Term Benefit #2: Low Dividend Taxes
While the capital gains tax may be in line with your regular tax rate, dividends have a maximum tax of just 15 percent. And a lot of dividend income is immune from taxes under certain thresholds. Why? Because Uncle Sam wants you to think of the stock market as a long-term wealth creation machine, not a casino.
That makes dividends one of the most tax-efficient ways to generate income, even better earning ordinary income or from the use of options trades like covered call writing. The best investment advice, whether from an accountant to a financial advisor, from a tax perspective, is to invest in dividend growth stocks for the long term and avoid having to sell in your lifetime. That’s a good way to avoid the noise of Wall Street.
Long-Term Benefit #3: More Time for Other Activities
Our time on earth is limited, and spending every free moment to make a few extra bucks in the stock market may not be worth the time. That’s time that could be spent creating art, studying an intriguing field, or learning the skills to get a big promotion at work.
When you’re investing for the long-term, instead of having to research trade after trade, you need to only spend a little bit of time monitoring your existing positions for potential dangers like deteriorating financials or a company’s new line of business.
That frees up a lot of time so that you can spend your time to enjoy your life as you see fit. That’s an advantage that may not show up on your tax returns, but it’s an important factor. And, it still leaves room for some trades in the market, when the time is right.