Knowing when to sell your shares is just as important as knowing when to buy. All too often investors will hold stock through the peak of its gains, only to see their hard earned profits decline. Either back to what they had paid, or even worse, into a loss. So how do you know when is the time to exit out of a stock position?
The Reality
Firstly, as an investor you need to understand that picking tops and bottoms is almost impossible. Reality is that no-one knows what the stock market will do the next day, or the day after. We can define a statistical probability and we can establish our “opinion” on what we expect a stock price to do, but all too often share prices will act completely independently to any potential expectation.
If picking tops and bottoms of the market were that easy, we would all be billionaires!
Institutional Firms
Institutional firms define an expected price that they target for specific companies, based on extensive research and analysis by teams of professionals. At these price levels, they will outline a Buy or Sell recommendation. But if you were to ever follow Institutional recommendations, you would regularly find that share prices tend to ignore the prices they set. All too often a share price will rise further than the target price, or fall well below.
Influences
The reason why is that although a team of very smart analysts can determine a theoretical price for what the company should be worth in the future, there are many, many more influences on the stock price, including investor sentiment, industry and competitor performance, natural disasters, and other institutional price targeting. In the end, the share price will do what the market says it should do. That is, the price of a stock is what it is … market derived!
But this fails to help us in defining when we should Sell our shares. How do we know when the share price has hit its peak?
How do we know?
Short answer is, we don’t. There is no way to define when it has peaked until the share price has started to fall back down. And even then, how do we know whether this is a short-term retracement, or what is called a ‘counter-trend’ movement?
When has a stock price peaked
To define when a stock price or the market in general has peaked, there are a few different methods that you can use. None of these are infallible however. What you need to define is how frequently the approach works, and whether that defines a reasonable point for you to be exiting the market, or selling your shares.
- Technical Analysis – using trend analysis techniques such as the Moving Average is probably the most popular method in modern stock market investment. Industry standards depict the 50-day moving average for a medium-term trend, and 100 or 200-day moving averages for longer-term. A method using 2 different time-frames, referred to as a Double Moving Average, is also exceptionally profitable. Other methods include defining Resistance levels where the price has previously peaked, and using Japanese Candlesticks to analyse buyer and seller strength. These methods require time to study and practice. Hence, you might consider a professional recommendation service to assist.
- Defined price levels – before you even enter into a position, you should have a clear price level in which you expect the share, or market, to achieve. You might define this yourself with your own analysis, or you might rely on a trusted source such as a research firm or publication. Just be aware, that if the price does not meet your targets and starts to fall away, you will need to have a planned exit strategy to limit any Risk of loss.
Hope and Pray
Outside of these two methods, the average investor will use the “Hope and Pray” approach. Hence, they tend to hold onto shares far longer than the peak, and sell towards lows as they can no longer wear the pain of a falling stock price.
Plan
The lesson from this discussion is that no matter what your approach to investing; fundamentally, technically, short-term or long-term, you need to have a defined plan of action. Sure there will be times when you exit a position and the share price continues rising. But more often than not, without a define method in how to manage your investment, you will lose more on your trade than you had initially wanted to Risk.
Matthew Brown – US Stocks & Options specialist
US Equity & Option Client Advisor
Halifax Investment Services
ASIC Australian Financial Services License Number – 225973
Matthew is an Authorised Representative of Halifax Investment Services (Halifax). Halifax provides broker services, including Full Service and Discount Services using multiple trading platforms.
