We’re now into the second day of May.
Get ready for the rehashed news stories telling you to ‘sell in May and go away’.
Small-cap analyst Tim Dohrmann pours cold water in this hackneyed old phrase in today’s second essay.
And yet, it does bring up a key point. How do you know when to sell a stock?
Here’s some breaking news.
The fact is you don’t know when to sell.
Or rather, you don’t know for sure when you should sell.
A selling decision may look like a great idea at the time, as the stock falls just after you sell it.
But it may not look so great when the stock doubles, triples or more over the next few months or years.
So while this advice may seem a cop out, the reality is that there isn’t a single cover-all formula for selling. That’s just in the same way that there isn’t a single cover-all formula for buying.
Don’t Overpay For Your Stocks
The most important aspect to consider when you think about selling is what your initial expectations were when you bought the stock.
Many investors forget about this during the heat and excitement of watching the stock market each day.
That’s especially true if they see the share price fall four or five percent in a short timeframe. Or if they see the share price rise 20% in a similar timeframe.
Their reaction is usually to panic, in both cases.
They’ll sell because they’re worried the stock will fall further, or they sell because they’re worried they’ll give up the ‘easy’ 20% gain.
So, was the investor right to sell? Or should they have held on?
In truth we can’t answer that because we don’t know the type of stocks involved and the investor’s expectations when they bought the stock.
This is why we recommend investors think carefully about a stock before they buy it. It sounds obvious, but many investors get over-excited and then jump into the market paying any old price.
It’s for that reason that we encourage our analysts to publish a maximum buy-up-to price when they recommend a stock. For instance, in the April issue of Australian Small-Cap Investigator Tim Dohrmann recommended a tiny medical company.
At the time the stock was trading for less than three cents. But to make sure that subscribes didn’t flood the market, unnecessarily pushing up the price, he told readers to pay no more than 3.7 cents.
It’s important to use an approach like this in small-cap stocks especially, as stock prices can be volatile.
Make Sure The Reward Matches The Risk
But even before you buy the stock you need to figure out if it’s worth your while investing in it.
That’s the same for blue-chip stocks and small-cap stocks.
For instance, by all rights you probably wouldn’t invest in a high-risk penny stock if you only expected to make a 3–6% gain over 12 months. The reward compared to the risk doesn’t stack up.
You can get that sort of return from a bank account or a dividend-paying, relatively safe blue-chip stock.
However, if you’re after a big triple-digit percentage gain from a stock, such as the potential an 800% gain Tim’s looking at for his medical stock tip, then punting on a high-risk speculative small-cap stock could make sense.
In that instance, seeing as you’re looking for a big (OK, huge) return you should be willing to accept short-term volatility that could see the share price fall a few percent or more.
In this case, if the stock fell 5% and you immediately sold, then we could say that was a panicked reaction. But that may not necessarily be a bad thing for you to do. It may just indicate that you’re not the risk-taking speculator that you thought you were.
At least now you’d know and you could either stick to what you perceive to be ‘safer’ stocks, or you could perhaps not stake as much on your next speculation.
It’s something we call the ‘sleep well’ test. If a stock is giving you sleepless nights then you’ve either made the wrong investment or you’ve staked too much.
Do You Pass The “Sleep Well” Test?
Once you’re comfortable with your investment, that’s when it’s time to sit back and hopefully wait for what you hope to happen — a rising stock price and/or a steady stream of dividends.
Realistically, you should own a combination of dividend stocks and growth stocks.
If you’ve picked the right dividend stock in the first place there really shouldn’t be any need to sell the stock for several years. That doesn’t mean you’ll hold it forever, things change…companies change…the markets change.
But if a stock is paying you a nice and steady income, which it may pay you for year after year, why bother selling the stock just for a ‘measly’ 20% gain?
Over the longer term a good dividend payer can give you a much bigger return than just 20%.
As for your growth stocks, this all depends on the opportunity. Ask yourself these questions about each of your growth stocks:
- Why did you buy it?
- Can it still achieve what you hoped it would achieve? Or has it already achieved what you hoped it would achieve?
- Has anything changed for the better or the worse?
Depending on how you answer those simple questions you should know exactly what to do.
Selling can be hard.
Just make sure that you invest the appropriate amount in a stock and pass the ‘sleep well’ test. Also regularly ask yourself those questions about each of your stocks.
Doing this should ensure that you don’t panic and sell your stocks before they’ve had the chance to make you the kind of gains that you hoped for when you first made the investment.
Cheers,
Kris+
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