Lesson 6.5 · 5 of 5 · Your first portfolio
When to sell a stock: good reasons, bad reasons and a written rule
It makes sense to sell when your reason for buying no longer holds, when you need the money or when one holding has grown too large in your portfolio. A price that has fallen or risen is not, on its own, a reason. A rule written in advance, on the day you buy, helps you stick to that.
Terms in this lesson
- Capital gain
- The difference between the price you sell at and the price you bought at.
- Rebalancing
- You bring your portfolio back to its target percentages, selling what rose and buying what lagged.
- Stop-loss
- An order that sells automatically if the price falls to a level you choose.
- Portfolio
- All your investments in one place: stocks, ETFs, bonds, cash.
Opening question
You bought a company’s shares because its sales were growing fast. The price is now down 15%, but sales are still growing. What has changed about your reason for buying?
You bought for the sales growth, and it is still there. Prices can fall for reasons that have nothing to do with the company: the whole market dips, interest rates rise. The useful question is whether your reason still holds.
It does not matter if you get it wrong: trying first helps you remember.
Good reasons to sell a stock
- 1The story has changed. Your reason for buying no longer holds: sales have fallen for several quarters, the company has piled on debt or management has hidden problems.
- 2You need the money. The goal you invested for has arrived: a house deposit, your child’s university fees.
- 3One holding has grown too big. A share has climbed to a third of your portfolio. Rebalancing brings it back to the percentage you chose.
- 4You’ve found something clearly better. Only if the gap covers the costs and any tax on the capital gain.
Check yourself
Which of these is a good reason to sell?
Losing its main customer changes the business, and so your reason for buying. The other three are about the price or other people, not the company.
Bad reasons to sell
- “It’s falling, I’ll sell before I lose more”Panic selling turns a temporary fall into a real loss.
- “I’ll sell once it’s back to what I paid”The market doesn’t know what you paid. Your purchase price says nothing about the future.
- “It’s gone up a lot, time to bank the profit”That can be right, but only if something has changed. Excellent companies often look “too expensive”.
- “Everyone’s selling”Headlines usually arrive after the price has already moved.
Real case
What does the data show about investors?
We sell winners too early and hold on to losers too long.
Terrance Odean studied 10,000 accounts at a US discount broker between 1987 and 1993. Investors sold 14.8% of the gains they had on paper but only 9.8% of their losses. Only in December, for tax reasons, did they sell losses faster. This is known as the disposition effect. And the shares’ later performance did not justify the habit.
Odean, Journal of Finance, 1998.
Myth or fact?
“As long as I don’t sell, I haven’t lost anything.”
Myth. The loss exists the moment the value falls; selling just makes it final. The useful question: would you buy the share today, at today’s price? What you paid no longer matters.
A selling rule written in advance
Definition
What is a selling rule?
One sentence written on the day you buy: “I sell if …”.
You write it while you’re calm, before any slump or euphoria. Then, when the price moves, you check the rule rather than your feelings. For a trader it might be a stop-loss at an exact price. For a long-term investment, the rule is usually about the company, not the price.
- Why I’m buying“Sales are growing by more than 15% a year and debt is low.”
- When I sell“If sales fall for two quarters in a row or debt doubles.”
- What I check, and when“The results, once a quarter.”
Check yourself
Which selling rule is easiest to check?
This exercise is in the free account, where we also save your progress.
Create a free accountWork it out
Your portfolio is worth £20,000 and one share in it has grown to £8,000. Your rule: no more than 25% in any single share. How many pounds of it do you sell to get back to 25%?
This exercise is in the free account, where we also save your progress.
Create a free accountWhat would you do?
A share you own is up 80% in a year, and the company is doing well. What do you do?
This exercise is in the free account, where we also save your progress.
Create a free accountWhat you learned
- Good reasons to sell are about the company, your need for the money or the size of the holding, not the price.
- Investors tend to sell winners too early and hold on to losers too long.
- A selling rule written on the day you buy, with clear numbers, protects you from emotional decisions.
One more time
The questions you got wrong, asked a different way.
Check yourself
One share now makes up 40% of your portfolio, though you planned a maximum of 20%. What reason to sell do you have?
An oversized holding means too much risk in one company, even if the company is doing well. Selling part of it brings you back to your plan.
You reached the end
Keep what you learned
With a free account we remember your lessons, bring back the questions you got wrong exactly when you need them and keep your streak.
Save your progress with a free accountLessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Terrance Odean, “Are Investors Reluctant to Realize Their Losses?”, Journal of Finance, 1998; Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long”, Journal of Finance, 1985. The worked examples are illustrations.