Many investors who hold individual shares know what it feels like to buy a share that drops sharply in price. Often, the temptation is to hang on to your investment in the hope that it will recover over time, as selling your shares will mean transforming paper losses into real losses.
Buying shares that shoot up in value can also leave you wondering whether to sell, as you may wonder whether your investment has further to go, but are nervous of missing out on gains by not cashing in the profits.
Deciding what to do next in either situation can be particularly difficult. Investment expert Warren Buffet says his ideal holding period for an investment is ‘forever’. Yet few investors are as skilled and confident as Buffet, and sitting through the ups and downs of stock market movements can be nerve-wracking.
However, there are strategies that investors can adopt to help them take a disciplined approach to selling investments. Here are some that you may want to consider. If you’re unsure when to sell your investments, seek professional financial advice.
Remember too that buying individual shares is a risky approach to investment, as their performance relies solely on the particular company concerned. For this reason, many people prefer to put their money into collective investments, such as unit trusts, investment trusts, open-ended investment companies (OEICs) and Exchange-Traded Funds (ETFs) to diversify their holdings. These pool your money with that of other investors, with a professional fund manager choosing and managing a wide range of investments on your behalf.
Keep your emotions out of your investment decisions
If you hold individual shares, it’s natural to want out when you see shares fall in value, and to feel a sense of excitement when they rise in value. The way our emotions change depending on the performance of stocks that we hold is why many of us sell our investments when markets are falling. However, our reactions may not make for good investment decisions.
Typically, the longer you are prepared to stay invested in the stock market, the greater the chance of positive returns. This means holding your investments for at least five years, and ideally far longer. There may be some short-term setbacks while invested in the stock market, but it’s important to try not to be distracted by investment performance over the short term, or let our emotions take over our decision-making.
During periods of stock market volatility, it’s important to think carefully about why you chose a share or investment in the first place before you sell. This could help you stand firm and avoid making rushed decisions, which could lead you to miss out on further potential for profits.
Of course, remember that past performance should never be seen as a reliable indicator of future performance, and investments can fall as well as rise, so you could get back less than you invested no matter how long you hold on to them.
Fixing a price at which you automatically sell
One way to take the emotion out of your investment decisions is to consider using a stop-loss policy. A stop order is an instruction to your stock broker to sell a share at a set price.
If the share price falls, the stop order may be triggered by automatically selling the holding. Investors typically are able to use a fixed-price stop-loss, or a ‘trailing stop’, which automatically rises in percentage terms as the price of the share moves up.
The benefit is that stop orders enable investors to avoid selling shares too soon that might still rise in value, and stop them from keeping hold of shares that are falling for too long.
To give a simple example of how a stop order works, take an investor buying a share for 110p. They set a stop at 105p. The share is sold when the share price drops to 105p or less, therefore helping to minimise losses. The shares would be automatically sold at the next available market price below 105, for example this could be 104.
Investors can also set a stop loss to retain a profit. For example, if an investor buys a stock at 110p, they may choose to set a stop order at 150p, retaining profits at this level. The level you set a stop order at depends on your investment strategy and attitude to risk.
Identifying overvalued stocks
If you have purchased a stock, and the share price has risen above a level you believe is fair value, it might be time to sell. However, deciding on whether a stock is overvalued can be difficult.
There are some signs that you may have an overvalued stock, based on your instincts, research and fundamental analysis of the market.
For example, has a company’s share price risen without any particular change in the company’s earnings or outlook? In this case, there’s a possibility the shares could have become overvalued.
There are many reasons why a stock might become overvalued, perhaps because the price hasn’t yet factored in a major company shift such as a change in CEO. Alternatively, perhaps the price hasn’t factored in a change in outlook for the industry in which the company operates, or a threat from a new competitor.
There are numerous ways of evaluating a stock and some are particularly technical. However, some, such as price-to-earnings (PE) ratio, can be particularly useful for investors. This involves dividing a stock’s current share price by its annual earnings, as a method of comparing a particular company to another in the same sector.
A particularly high PE ratio could be a sign that the stock is overvalued, suggesting there is more risk attached to investing in the stock. However, a company PE ratio should always be considered alongside the sector’s PE to determine how a business is performing in comparison to its peers.
Past performance shouldn’t be taken as a guide to future performance and the value of your investments can still fall as well as rise.
Please bear in mind that this article is for general information purposes only. If you are unsure about when to buy and sell investments, seek professional independent advice.