Saturday, May 10, 2014

When to sell a stock

The first thing that we always look at is the market. If the overall stock market is not going in the direction you want it to be, consider selling out of your stock positions. However, if you’re in the market for the long-term, it’s probably best to wait out a bear market. There are three main factors that direct the movement of the stock market:  inflation, interest rates, and the stability and profitability of key companies. The truth is, there is no way to predict the market, but as far as indicators go, you will not do better than watching inflation and interest rates.

Typically, when interest rates go up, so does inflation, and stock market activity slows down. Interest rates are an indicator of how much it costs to borrow money. When interest rates are high, people are slower to borrow to buy houses or cars. On the other hand, when the interest rates are low, consumers tend to be more willing to take on debt, since paying it off will be less expensive in the long-run. Thus, when people are out there spending money, the economy grows.

Inflation, as the name suggests, goods and services cost more and money doesn’t buy much. Inflation occurs at times of high employment because as more people make money, prices go up. A side effect of inflation is an increase in interest rates. The government tends to raise interest rates when the economy shows sign of inflation, in order to slow people’s buying and curb the growth of the economy. But higher interest rates also make it more expensive for companies to raise capital by borrowing and/or issuing bonds, and that cuts into their profitability. Also, when interest rates are high, yields go up on bonds and they begin to look like better investments, instead of stocks. Thus, inflation is an enemy of the stock market.

When to sell a stock is really a hard decision. You have to set rules for this. One of which is that if a stock goes down, say, 8% or more from the price you paid for it without any obvious reason, you better get out of that stock. Stick to your rules. If you don’t, there will come a time when you do not sell, and the stock will go from 25 to 22 to 19 to 17 to 14 to 11 to 9 to belly up. Remember, when a stock goes down 50%, it has to go up 100% for you to break even. It usually is harder for a stock to go up than it is for it to go down.

The above rule is not absolute. If you feel that the stock is being affected by circumstances that will change your opinion, then, you buy more as its prices goes down. The rule of the thumb is that if you are not going to sell, you better be buying more. This is where peso cost averaging comes in. The best way to make money in the market is to be a very disciplined investor and not to get emotional. Great investor like Warren Buffett profits greatly by keeping a solid game plan.

There are other indicators when to sell stocks, such as:

·         Volume. Watch the volume of shares trade daily in your stock. When you see the volume increasing dramatically at the same time that the price of the stock is decreasing, you should take that as a danger sign.
·         Earnings. If the last two or three quarterly reports show earning per share going down significantly rather than up, this is a bad sign.

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