How do you know when it’s time to sell a winning stock?
Most investors have asked themselves (or Cabot analysts) that question on at least one occasion.
When a stock has appreciated—a lot or a little—since you added it to your portfolio, it can be hard to decide whether to lock in the profits or hold out for even more upside. In fact, we know from our conversations with subscribers that selling winners is one of the hardest decisions for most investors to make.
5 Rules for Deciding When to Sell a Winning Stock
1. Sell After a Set Period of Time
This is not a common sell discipline, but it’s a discipline (important) and it’s simple and easy to follow. And it works for Neil MacNeale, the editor of 2 for 1 Stock Split Newsletter. MacNeale’s investing strategy is based on research (the Ikenberry/Rankine study) showing that stocks enjoy two to three years of outperformance after undergoing a two-for-one split. So, with some flexibility built in for profit-taking, he holds each of his picks for two and a half years—30 months—and then sells it.
The “sell after a set period of time” discipline can work well when a) you’re starting with investments that are already undervalued and b) you have already taken some profits off the table after the stock appreciated significantly, locking in part of a gain.
The most important part of this sell discipline, though, is that it is based on and works well with MacNeale’s investing system. It’s most useful for investing systems with a time-related component: like buying undervalued cyclical stocks, for example.
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2. Sell When the Negatives Outweigh the Positives
This is a more popular, but less rigid (and thus harder to follow) sell discipline. In this kind of system, you hang on to a stock that’s performing well until the factors supporting further upside begin to be overshadowed by factors suggesting downside.
If you’re following this strategy to sell a winning stock, you’ll want to have a comprehensive understanding of the upside factors that you considered when you made the initial purchase. If the stock’s story remains the same, there’s no need to close out your position. However, if the technical or fundamental factors that supported your initial buy have deteriorated, that’s when you’ll need to consider selling.
Although it can be tricky to weigh the positive and negative forces acting on a stock if you’re not a professional investment advisor, this system does offer the promise of safeguarding gains in winning picks by selling before a downturn begins.
3. Sell Some to Lock in Gains
Another way to safeguard your gains is to take partial profits in your winners while their uptrends are still strong.
If you have a big profit in a stock, but still believe in the stock’s story and technical strength, you can safeguard some of your gain by taking partial profits off the table while leaving the rest to take advantage of further upside.
If the stock has run especially far or fast—particularly if it’s doubled or more—one method I’ve seen many of our contributors use is to take their original investment off the table and let their profits ride. That way you feel secure that you can’t “lose” any money if the wild ride ends (after all, you already got your original investment back).
4. Sell When a Winning Stock Reaches Your Target Price
Selling a winning stock when it reaches your target price is another system-specific sell discipline that has some advantages. For one thing, choosing a target sell price before buying a stock makes the sell decision much easier—your judgment isn’t clouded by how much money you’ve made on the stock. It also forces you to reconsider how much upside may be left in the stock at current levels. Of course, like selling after a certain period of time, you should build some flexibility into the system, to ensure you aren’t missing out on big winners or letting profits evaporate.
Alternatively, you can use tools like trailing stops (or mental stops) which rise over time. In exchange for slightly increased downside risk if the trade loses momentum, you’ll enjoy a higher likelihood of participating in unexpected market rallies. Because both of these strategies require a willingness to look back at a trade that you may have exited too early, it’s important to stay disciplined and look forward to the next trade.
5. Sell When the Chart Turns Down
Finally, there’s the defensive sell, to protect your investment and whatever profits you have when a stock starts to weaken. This is probably the most important sell discipline and should be used regularly by every investor. This is a more extreme version of selling when the negatives outweigh the positives. In this scenario, you’ve seen a fundamental change to the story of your investment which is causing the entire market to revalue a company.
As you can see, there are many answers to the question of when it’s time to sell a winning stock. In many ways, the decision to sell a winning stock is much more complicated than realizing you need to sell a loser. Losers should always be sold because they’re doing poorly, but there are a wide variety of reasons to sell a winning stock.
Do you use any of these selling strategies? If so, which?
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*This post has been updated from a previously published version.