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Abu Dhabi, UAETuesday 20 November 2018

Knowing when to sell a stock as key as knowing when to buy

Choosing the right time to exit the market is an important investment skill all investors should master

Some analysts say the buy and hold philosophy adopted by investment guru Warren Buffett no longer cuts it. Photo: Getty Images
Some analysts say the buy and hold philosophy adopted by investment guru Warren Buffett no longer cuts it. Photo: Getty Images

Buying the right stocks and mutual funds at the right time is a basic investment skill, but it is not the only one you have to master.

You also have to know the right time to sell up and take your profits - or cut your losses.

Knowing when to sell is just as important as knowing when to buy, but it does not attract the same level of attention. It should do, otherwise you could watch all your early profits turn into long-term losses.

Vijay Valecha chief market analyst at Century Financial Brokers, says many still follow venerated investment guru Warren Buffett who has always extolled the virtues of buying and holding for the long-term, but the world is changing.

“The average tenure of a company in US S&P 500 has fallen from 33 years in 1964 to 24 years in 2016, and is expected to come down further to 12 years by 2027," says Mr Valecha.

Creative destruction is now the new norm, he adds: “In the last 10 years, Facebook has replaced Orkut, Netflix has challenged the dominant cable TV companies and who knows, Elon Musk’s Tesla might lead to the extinction of conventional automobile companies.”

In this fast-changing world the buy and hold philosophy no longer cuts it. But selling at the right time is not easy.

"You need to keep a close track of your investments and analyse competition in the industry, barriers to entry and the threat of new or substitute products that can disrupt the sector," says Mr Valecha. "If you see trouble ahead you should consider exiting your position, even if it means selling at a loss."

Jordan Hiscott, chief trader at Ayondo Markets, argues that the decision to sell should be made right at the start of the investment process, when you initially decide to buy the stock. “You should have already identified the target price at which you hope to sell at a profit. You could also set yourself a downside stop-loss level, the point at which you sell up and cut your losses,” he says.

This, Mr Hiscott says, helps put you in control of the two primary investor emotions: fear and greed: “Fear that you will make a loss and greed that you won’t make enough profit."

Setting yourself targets like this should remove emotion from your trade, and improve your chances of making a profit.

This should not be set in stone, though. "A significant event, such as a merger or profit warning, might change the fundamentals in either direction," says Mr Hiscott, adding that practical considerations such as an upcoming tax bill may also determine your time decision to sell.

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Gordon Robertson, director at Investme Financial Services in Dubai, says there are many tools to help you decide when to sell, but no perfect solution. “Otherwise, we would all be rich.”

One problem facing private investors is that they are at the mercy of their emotions. “They tend to fall in love with stocks and do not exit, or they are over confident in their ability to spot good stocks and therefore take greater risks," says Mr Robertson. "They compound the danger by either selling the stock too late, or too early.”

Mr Robertson says one way to protect yourself is by putting a trailing stop-loss under the current share price, say, setting it around 10 per cent. "If the stock or exchange traded fund drops then you will automatically sell, which would prevent further disaster. You can still follow the trend all the way upwards, while limiting losses or locking in profits on the way down."

Even this is not perfect and does not guarantee success, and is particularly dangerous with volatile stocks. One of your holdings might plunge, say, 11 per cent, triggering your stop loss, then quickly rebound, possibly all on the same day. By then your position will have been closed, so you have been locked out of its recovery, and stuck with your loss.

Steven Downey, chartered financial analyst candidate at Holborn Assets in Dubai, says the decision to sell is partly determined by your own investment philosophy.

He says there are two prime philosophies, so you need to work out which one you subscribe to, consciously or otherwise.

The first school of thought is that markets are highly efficient, and all stocks are therefore accurately priced, given the relative risks and rewards. “If you believe that, then you must also believe there is little point in trying to time the market," he says. "So the only time you would sell is if you need to rebalance your portfolio to adjust your risk profile, or if you need to get your hands on the money.”

Mr Downey says the second view is that markets are not efficient, and stocks may therefore be under or over valued at any time. “In this case, you might decide to sell once the market has risen above a certain value, which you can judge using various measurements including the Cyclically Adjusted Price/Earnings Ratio, or CAPE.”

By this measurement, the US stock market is currently massively overvalued, trading at 32.57, double its long-term 16.88.

That is higher than Black Tuesday in 1929, when it topped 30 just before the Wall Street crash, although below its record peak of 44.19 in December 1999, shortly before the dot-com crash.

The US stock market could be ripe for a crash, or it could climb higher. Nobody knows for sure. The decision to sell is never easy.

“You should be guided by your philosophy and investment strategy, which need to be well thought out," says Mr Downey. "Don’t just shoot from the hip.”

Laith Khalaf, senior analyst at UK wealth advisory firm Hargreaves Lansdown, says there are a number of reasons to sell investments, but none of them involve looking into a crystal ball and trying to time the market. “One good reason to sell is when your original investment case no longer holds. Perhaps developments have proved you right, or wrong, and the time has come to take your profits, or to accept losses and look for other opportunities.”

Do not simply sell on adverse share price movements but consider how it relates to the company’s underlying business performance. “Sometimes a price dip can be an opportunity to top up if there isn’t a good reason for the stock coming under pressure,” says Mr Khalaf.

Alternatively, Mr Khalaf says you might want to sell if a company that looked undervalued when you bought it now looks expensive, or its growth potential has now been largely realised. “It might have been the subject of a takeover bid, or maybe you’re unconvinced by the new chief executive’s change in strategy,” he says.

Similarly, if you invest in mutual funds, you might decide to sell one of them if a successful fund manager leaves.

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Richard Hunter, head of markets at online trading platform Interactive Investor, says it is generally accepted that it is more difficult to sell a share than to buy one. “If you, the investor, are in profit, will you miss another leg up by selling now? Or, if you are losing money, can you bring yourself to admit defeat by selling? It goes against natural human psychology.”

This is less of a problem if you are a committed fan of Warren Buffett, who famously said that his “favourite holding period is forever”.

For everybody else, there are certain points that might trigger a decision to sell, Mr Hunter says. “If the company you bought is no longer the company you hold, for example, it has changed its strategy, direction, management, customer focus or lost its unique selling point, it may be time to exit.”

A profit warning could also point the way. "You might decide this is the thin end of the wedge and bite the bullet rather than waiting for the next warning,," says Mr Hunter, adding that a change in your personal circumstances might also be a trigger point.

“If you need to raise some cash urgently you might sell, as shares have the advantage of being a highly liquid investment, as you can get your money quickly.”

Another reason to sell is if your attitude to risk has changed. "Investors tend to become more cautious as they get older, and may also wish to switch from growth to income stocks as they move closer to retirement,” says Mr Hunter.

You might need to rebalance your portfolio in other ways. "For example, if a stock has performed strongly it could have a disproportionate weight in your portfolio. You do not want to put too many of your eggs in one basket,” Mr Hunter explains.

Alternatively, you might want to "top slice" your holding. “If, say, you invest $5,000 in a stock and its share price has risen to $15,000, you could sell $5,000 to cover your initial purchase costs so the remaining shares represent pure profit.”

Some investors buy with a pre-set target in mind, say, 10 per cent growth. “If your stock achieves that, then you can happily sell. It is never wrong to take a profit," says Mr Hunter.

Another reason, he says, for selling is that you foresee an economic downturn. “At that point you could sell your riskier cyclical or growth shares and take relative shelter in lower risk defensive stocks.”

However, it is very hard to predict a downturn. Economists have been predicting a crash ever since the last one, and anybody who sold all their investments will have missed out on a bull run that has lasted almost a decade.

Timing the stock market in this way is notoriously difficult. So do not be too hard on yourself. There is no such thing as the perfect time to sell.