The only thing harder than buying a stock is deciding when to sell. Whether you consider yourself a long-term investor or not, it is always good practice to keep Warren Buffett's mantra in mind: "Rule No.1 is: Don't Lose Money. Rule No.2 is: Don't Forget Rule No. 1."

Whether you need to cut your losses or take a profit, read on for some simple tips you can use to help you decide whether to sell.

Great Stock, Battered Sector

Traders often face the difficult decision to sell a stock that they feel is the best in the market.

But what if you're watching a stock decline daily - and losing money day by day?

Although many traders will resist selling a stock - particularly if it's a great company with great returns and little debt - often, the reality is that despite its charm, a stock that's performing badly may be in a sector that is being battered. (For related reading, see Sector Rotation: The Essentials.)

History is a great teacher when it comes to this scenario: When a bear market occurred following the dotcom boom, the technology sector was battered brutally and it didn't just take down the stocks with massive debt and no income. Profitable companies with solid business structures were severely devalued as well. In many cases, those who held on to tech companies are still waiting for those leading technologies to return their losses.

Lesson: If you own a stock in a sector that is being battered, you should consider selling because even good companies aren't safe from the roar of the "bear". Buying and selling stock today is easier than ever and relatively cheap. Even for long-term investors, sometimes it's necessary to do a short-term sale to comply with Buffett's first rule: Don't lose money! (For more, see Limiting Losses.)

Emotional Attachment
If you become emotionally attached to your stocks, you'll end up paying with losses. Part of the reason good investors fall prey to this trap is that they put so much work into finding the "right" stock. They read stocks books as thick as doorstoppers, devise brilliant stock-picking systems and carefully input this criteria into a stock picker. Finally, a careful investor will narrow his or her choice down to one "gem". Sound familiar? But if you let this stock become your pride and joy, you may suffer grave losses for it. In Jim Cramer's book, "Real Money: Sane Investing in an Insane World" (2005), he says that investors should love a stock when it's making money; when it isn't, cut it loose!

Lesson: Emotional attachment to stocks is nothing more than human nature and wanting to be right. Do you want to be right - or rich? (For more, see Removing The Barriers To Successful Investing.)

Unrealized Profits
A profit isn't a profit until you've taken it off the table. Period. Despite this, many investors like to inflate their egos by viewing their stocks online and relishing how much money they've made. In reality, you haven't made a penny until you press the "sell" button.

When a stock is shooting for the moon, you may begin to sense it's out of control - the price-earnings ratio becomes very inflated, everyone on television is talking about it and you're beginning to wonder just how much higher it can possibly go. This many be a good time to go for the "sell one-third" or "sell half" rule. This way, you can take some profit off the table and also keep some stock on the table so that if your stock does hit the moon, you won't be left kicking yourself for selling out of your position.

Lesson: Although the tax rate is substantially steeper for taking a profit if you've held the stock for less than a year, it's often better to have part of something than to risk having less - or nothing - once the year is through. (To learn more, read A Long-Term Mindset Meets Dreaded Capital-Gains Tax.)

When to Sell
The real secret to knowing when to sell is to read, read, read - and then read some more. We're all busy, but take a few minutes out of the day or week to know what's going on with the market, with the economy and with your stocks in particular. Reading is like insurance: the more you know, the more you are protected.

Lesson: If you have your strategy firmly in place, one simple piece of information can give you the power you need to take action, take a profit or prevent a loss. Find a newsletter or e-letter (many are free) that provides pertinent economic data and analysis from analysts and economists. This will help to provide you with the information you need to determine where the markets might be headed.

Conclusion
There is no exact science to knowing when to sell, only indicators that can give us clues. Learning from the mistakes of others is a great strategy for avoiding making those same mistakes yourself. If a solid company has a downward spiraling stock price, look for clues as to why and find out what is happening within that sector. Remember to keep a clear head when evaluating stocks and don't become emotionally attached to them. Lastly, knowledge is powerful. Read the books of those who have been successful trading and investing because they offer a wealth of knowledge and experience. There are many factors that affect the financial markets, but if you're willing to put in the time and effort to read and research your investments you will be well prepared to take profits and avoid losses.

To see other common investor errors, see Seven Common Financial Mistakes and Learning From Others' Mistakes.

Related Articles
  1. Professionals

    Social Security 'Start, Stop, Start' Explained

    The start, stop, start Social Security strategy is complicated. Here's what retirees considering it need to consider.
  2. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  3. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  4. Professionals

    Is it Time to (Finally) Push Kids Out of the Nest?

    Parents should make sure their kids realize their home is a launching pad not a landing spot, and advisors can help clients talk to their children.
  5. Professionals

    The Rich Get Richer: Global Wealth is Rising

    Global wealth is rising and expected to continue. Advisors should know that the wealthy value fee transparency, performance.
  6. Professionals

    Top Questions to Ask When Choosing a Robo-Advisor

    Think a robo-advisor might be the right choice for you? Be sure to ask these questions first.
  7. Professionals

    Are Hedge Fund ETFs Suitable for Your Portfolio?

    Are hedge fund ETFs right for you? Here's what investors need to consider.
  8. Professionals

    Index or Target Dates in 401(k)s: Which is Better?

    A common question is whether or not plan participants should choose index or target date funds in a 401(k). The answer depends on different scenarios.
  9. Professionals

    How to Bring Up a Prenup with Clients

    Prenups aren't just for the rich. Here's how to help clients agree to one if you think they'll benefit.
  10. Professionals

    How to Avoid the Inheritance Nobody Wants: Debt

    With the biggest transfer of wealth underway, advisors need to ensure that clients don't also inherit debt.
RELATED TERMS
  1. Financial Singularity

    A financial singularity is the point at which investment decisions ...
  2. Hunting Elephants

    The practice of targeting large companies or customers.
  3. Head-Fake Trade

    A trade where a stock or market appears to be making a move in ...
  4. Crowded Short

    A trade on the short side with an overwhelmingly large number ...
  5. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  6. Endowment Effect

    The endowment effect describes a circumstance in which an individual ...
RELATED FAQS
  1. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  2. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  3. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  4. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!