Today, anyone can open a trading account and buy a stock. Investors are no longer constrained by high commissions and minimum account balances. So buying a stock or investing in the stock market has become incredibly simple over the years. However, deciding when to sell a stock, take a profit or book a loss is still as hard as it ever was.
Is it time to sell?
Over the years I've realised that deciding when to sell a stock is perhaps the most difficult part of investing. Sell too early, and you can miss out on a huge profit. Sell too late, and you can see gains erased or losses grow as the market moves against you.
Unfortunately, deciding when to sell a stock isn't a precise art. You'll never be able to pick the top or bottom of a market with any degree of accuracy, so there's little point trying. It's best to leave the market timing to traders, who have more experience trying to decipher market movements.
Long-term thinkers need to take a long-term view of equity investments. Just because a stock is down 5% in one day is no reason to sell. That said, some people also use long-term investing as an excuse not to sell a stock when an investment case changes, and this is a terrible decision.
Three reasons to exit
There are three main reasons for a long-term investor to sell a stock. The first and most important is management deceit. If an investor has reason to believe that a company's management has lied about the firm's financial profile or business prospects, there's a good argument to sell the stock and never look back. Management has a duty to look after shareholders' capital as those shareholders are ultimately a public company's owners and should be kept informed. But if management misleads its owners, why should the owners continue to hold the business as part of their portfolio. What else has management lied about to keep other stakeholders happy?
The second reason to consider selling an equity holding is if your initial investment thesis no longer holds true. If a company has changed its business model, diversified into an industry you can't understand or chased growth at any price, your original investment thesis may no longer apply. In this scenario, there's no shame in selling. Investing in something you don't understand can quickly lead to losses, and if you no longer understand part of the business you own, or where it's heading, it could be time to sell up and move on.
The third reason to justify selling a stock is simply that you've found something better out there. Investing is about picking the best opportunities with the highest reward and least risk. If a stock you've had your eye on for some time drops 20% for no reason, it would be mad not to capitalise on the opportunity, which may require selling another holding. In the long-term, this decision may likely be the correct one.
Make money, not mistakes
Mis-timing the market could crush your long-term investment returns. A recent study conducted by financial research firm DALBAR found that the average investor realised an annual return of only 3.7% a year over the past three decades, under-performing the wider market by around 5.3% annually. Such a poor performance could literally cost you hundreds of thousands of pounds.
Trying to time the market is just one of the mistakes investors make that was identified by the DALBAR study. To help you realise and understand the other most common mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.