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When to Sell a Stock? - Making the Right Selling Decision
One if not the most important question in investing is "When to sell a stock?" We'll find an answer to that question today.
“I believe there are three reasons, and three reasons only, for the sale of any common stock.” - Phil Fisher
First of all, there’s a difference between selling for personal reasons and selling for financial reasons.
Selling for financial reasons aims to maximize one’s returns on investment. Selling for personal reasons is for retirement, paying for your kid’s education, buying a house, etc.
We will focus on selling decisions that maximize the return on your investment since those are the relevant ones to become a better investor.
1. Wrong Thesis
Every buying decision should be based upon thorough research and a detailed investment thesis that can be used as an anchor and benchmark to evaluate the investment in the future.
This thesis should include your expectations on growth, profitability, risk, and the destination of the company in question. Where is it heading, and how does it plan to get there?
If your thesis is good, it’ll make comparing reality to your expectations easy, and mistakes should be clearly visible over time.
The hard part, however, is to admit these mistakes. Once we make a decision, it’s hard for us to keep a neutral, objective look (Keyword: Confirmation Bias).
Thus, the real challenge is to be honest with ourselves, admit the mistake, and act accordingly.
The most common mistake is to wait until you’re “even” with your investment. Our ego can’t handle making a loss even when we know we’ve made a mistake with the investment.
Let me quote Peter Lynch here: ”The stock doesn’t know that you own it.” It doesn’t care when you are even.
Sell as soon as you realize your mistake.
2. Changing Facts
Another option is that your initial thesis was right, but unexpected changes occur within the company. The consequence should be the same as when you’ve made a mistake within your thesis, sell the stock.
A question that simplifies the decision process a lot is the following:
Would I buy the company right now if I didn’t own any shares yet?
If so, hold on to your shares. If not, sell immediately.
To answer that question, you can use Phil Fisher’s list from my latest article: Phil Fisher’s Rules for Buying Stocks.
In reality, certain factors change pretty often, and investors should be on the lookout for these:
Management changes its aim. With a more successful and bigger company, managements tend to change their leadership style, and it’s not uncommon that they also change their reward/bonus system.
Management gets replaced. It can also happen that the old management team is replaced by a new one.
The growth prospects of the market are exhausted.
3. Opportunity Costs
“Intelligent people make decisions based on opportunity costs.”
- Charlie Munger
When another opportunity offers better returns at the same risk profile, the only right decision is to sell the current position and invest in the better opportunity.
However, there’s a risk to an opportunity cost-motivated sale. That risk is misjudging the new opportunity and missing out on the investment you already make.
Of course, this is always a risk, but it’s extra tricky in this case. That’s because there are some biases that might lead us to make wrong and hasty decisions.
The first is a Bias to Action: Investing takes patience and confidence in your decisions. When nothing happens to your stock for a while, you tend to get nervous and question yourself. At that point, it is easy to look for new opportunities and convince yourself quickly that there are better ones out there.
Thus, you might overlook problems with the supposedly better investment and act too fast.
The second one is the Overconfidence Bias: Because we want to find a better opportunity, we become overly confident in the first best alternative and neglect all the thorough research and deep knowledge we gathered over a long period on the old investment.
You should consider these biases when looking for new and better opportunities. Yet, if you’re confident you found a better alternative and considered all the above aspects, act on it.
These were the three most important reasons to sell a stock. A lot of it is based on Phil Fisher’s book Common Stocks and Uncommon Profits. You can find that and many other books on my Bookshelf.
If you can think of other reasons to sell an investment, let me know in the comments!
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