Choosing when to sell a stock can be a difficult task. For most traders, it is hard to separate their emotions from their trades, and the two human emotions that influence traders when they are considering selling a stock are greed and fear. Traders are afraid of losing or not maximizing profit potential. However, the ability to manage these emotions is the key to becoming a successful trader.
For example, many investors don’t sell when a stock has risen 10% to 20% because they don’t want to miss out on more returns if the stock shoots to the moon. This is the result of greed and a desire that the stock they picked will become an even big winner. On the flip side, if the stock price fell by 10% to 20%, a good majority of investors still won’t sell because of their reluctance to realize a loss in the event that the stock rebounds significantly. There is the additional fear that they might end up regretting their actions if the stock rebounds.
So, when should you sell your stock? This is a fundamental question that investors struggle with. Fortunately, there are some commonly used methods that can help investors make the process as methodical as possible, and remove any emotion from the decision. These methods are the valuation-level sell, the opportunity-cost sell, the deteriorating-fundamentals sell, the down-from-cost and up-from-cost sell, and the target-price sell.
The first selling category is called the valuation-level sell method. In the valuation-level sell strategy, the investor will sell a stock once it hits a certain valuation target or range. Numerous valuation metrics can be used as the basis, but some common ones are the price-to-earnings (P/E) ratio, price-to-book (P/B), and price-to-sales (P/S). This approach is popular among value investors who buy stocks that are undervalued. These same valuation metrics can be used as signals to sell when stock becomes overvalued.
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