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How To Know When You Should Sell Your Stocks




Investing in good companies is hard to do. Maybe you have a big winner (or maybe a big loser), what should you do next? Hold? Buy more? Sell? Let's go over some of the reasons why you should sell.



There are better opportunities


Sometimes you need the money to buy another stock. If you have a big gain in a stock you own you can sell part of it to help fund that new investment. If you have a big loss and don't believe in the company anymore then maybe you should sell and take the loss. It will free up whatever remaining capital is left and will also free up some mental capital to follow your new investment. Remember, you only have so much mental bandwidth to follow all your investments.



When the story changes


Sometimes the story changes. Maybe management doesn't follow through on their game plan or a competitor has come in and turned the landscape upside down. It's hard to predict the future and how it will play out for each business. It's okay if the story changes. Sometimes it happens for the worse, sometimes for the better. If the story changes, in a bad way, then it's time to cut ties.



Price stop loss


You'll see this used by professional traders more than anyone. Before they enter a trade they'll figure out where they are getting out, both on the upside and the downside. By doing this they can define a clear risk to reward. If they aren't making $3 for every $1 risked, they probably aren't entering the trade. A big part of this strategy though is execution. If the stock drops below the price they planned on getting out - they must get out. If they don't, the math doesn't work anymore. Investors can use this discipline as well. It will help them define prices to take profits on the way up and to get out if they are wrong.



Using valuation


Once in a while you'll have a huge winner that just continues to run higher. Think NVIDIA. At what point do you sell? This should be written down beforehand so you don't jump the gun or hold longer than you should. Maybe you use price to earnings, price to sales, or price to book. Maybe you use a combination of the three or use those metrics against their competitors. There is no shortage of valuation metrics but sticking to your game plan is the most important thing here. Being flimsy will result in more luck than skill.



Conclusion


When buying a stock you should think to yourself, "If the market were to close tomorrow and open five years or even ten years from now, what would I want to own at that point?"


By asking yourself this question you'll be able to eliminate a lot of the noise in decision making and hopefully be able to hold your stocks for a longer period of time. But the story does change and using the practices above can help you make a prudent sale.


Remember, there are always tax ramifications for selling in a taxable account and you'll want to consider that too.

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