One of the mistakes that many traders and investors make is not thinking enough about selling. For investors, the old axiom is to buy and hold forever. This “never sell” strategy works wonderfully during lengthy bull markets but it can lead to major losses when a bear market or correction eventually arrives.
To help alleviate some of these challenges, here are six time-tested selling strategies that work for many investors and traders. At the least, after buying a stock or ETF, think about when and at what price to sell.
1. Buy late and sell early: It’s been drilled into most investors and traders to “buy low and sell high.” While that’s a wonderful goal, the reality of trading and investing is that getting the timing right is excruciatingly difficult.
Here’s the opposite view: Legendary stock speculator Bernard Baruch, when asked the secret of his success, replied: “I always buy too late and sell too early.”
Buying late means that you don’t attempt to get the lowest possible price. Instead, wait patiently for the stock to prove it is a winner. Rather than trying to squeeze every last penny from a transaction, sell at a spot that brings a decent profit.
Although Baruch’s rule goes against nearly everything taught about trading and investing, following it helps to reduce emotions — especially fear and greed. To follow this method, you must be willing to miss potential opportunities in order to reduce risk. It also means being willing to buy at a higher price than everyone else, which is annoying for those trying to get the best entry prices.
2. Sell gradually on the way up or down: Instead of selling a position all at once, either for a gain or loss, you may want to “scale out” of a position. For example, let’s say you are “long” 600 shares of a stock at $25 per share. If it reaches $27 per share, consider selling 200 shares. If the stock keeps moving higher, sell another 200 shares.
Now that brokerage commissions are free, there is no penalty for scaling out of winners. You can also scale out of losers, although I have found that once you have identified a loser, it is often better to sell all at once and move on to the next trade.
3. After buying, create target prices or percentages: One method of helping to determine when to sell is to create a target, either by price or percentage. For example, if you bought a stock at $25 per share, you might set a target price of $28 per share.
Keep in mind that you do not just choose a target price out of thin air but identify it based on fundamental or technical analysis. Technical analysis, such as using moving averages, is a more precise and accurate method when picking target prices.
Another idea is to choose a percentage-based target price, for example, sell when the stock or ETF rises by 5%. Again, rely on technical indicators to determine an appropriate percentage.
In addition, if you can’t believe how far and fast the stock (or other financial product) has gained, instead of continuing to hold for an even bigger score, take the opportunity to sell some of the position, no matter how small.
There is nothing worse for a trader’s ego and account than to watch huge gains disappear because money wasn’t taken off the table. This is the time to be disciplined, and that means not only having selling targets, but selling when they are hit.
4. Sell losers quickly: Here is a rule I follow: Sell winners slowly but sell losers quickly. Not everyone may agree with this, but the alternative is risky: holding losers too long until most or all of your gains have disappeared. Just as you should have price and percentage targets for your winners, do so for your losers. We all have hopes that a losing investment we own will miraculously rise from the ashes and bring profits. More times than not, this is wishful thinking. That is why it is so essential that you prepare in advance for worst-case scenarios.
I have learned from experience that once a loser is identified (based on technical indicators such as moving averages), sell at the first opportunity. That one rule has saved me countless amounts of money. Face reality and admit you are wrong. Then move on.
As most traders know, it is recommended that you set a mental or physical stop loss in case you are wrong. Typically, selling at a 7% to 10% loss is appropriate, but feel free to adjust the amount as you see fit. The main point is that you must avert letting a small loss turn into a huge loss.
Your internet brokerage firm likely allows you to set alerts or sell triggers when certain prices or percentages are reached. Automating the selling process removes emotion and forces the security to be sold.
5. Take profits regularly: Although this might seem obvious, especially when discussing selling strategies, don’t forget to periodically take profits. In addition, it’s essential to review and analyze your portfolio on a regular basis and make selling decisions, such as dumping losers. If you have extreme gains, bigger than you ever imagined, it would be only prudent to book some of the profit and diversify into other financial products.
6. Have a list of rules or a plan: Any of the above ideas that you agree with should be turned into a list of rules. Another idea is to create a “selling script” or plan that spells out specific selling instructions, for example, reducing a position if it gains 10% or more in one day.
Following written rules helps keep emotion out of your selling decisions. It also keeps you from “playing it by ear” or panicking during volatile markets.
Of course, it’s more fun to buy than to sell. Yet it is a huge mistake if you neglect to develop and apply selling strategies. While your ultimate goal is to make a profit, more importantly, you must take steps to protect those hard-earned gains. After all, there is nothing more frustrating than watching huge gains turn into dust.
Michael Sincere (michaelsincere.com) is the author of “Understanding Options“ and “Understanding Stocks.” His latest book, “Make Money Trading Options: Short-Term Strategies for Beginners,” introduces simple option strategies to beginners.