“Buy low and sell high” appears as a simple strategy to make money in the stock market. This strategy is simple in theory but hard to practice. Buying is relatively easy. There are many proven strategies for smart buying like contrarian investing, coffee can investing, value investing etc., which have made many investors wealthy. But, are there any time-tested strategies for selling? Technical analysts would tell traders that charts give sure shot sell signals. But for the lay investor are there any strategies for selling?
Stock market legends like Warren Buffet made their fortune through a strategy of ‘buy and hold’. Buffet once remarked that his favorite holding period was ‘for ever’. He went on to add that “if you are not comfortable holding a stock for 10 years, you should not hold it for 10 minutes.” It is important to understand that fortunes are made in the stock market by holding good quality stocks for long periods, during which time, they become multi-baggers.
So, should an investor not sell at all?
Certainly not! There are occasions that warrant selling. Let’s look at the important ones.
When the market is hugely over-priced and is in bubble territory
There is an apocryphal story that during the winter of 1928, Joe Kennedy, who made a fortune from the stock market, decided to stop to have his shoes shined before he started his day’s work at the office. When the shoeshine boy finished his job, he offered Kennedy a stock tip: “Buy Hindenburg.” Kennedy soon sold off all his stocks and escaped from the Great Crash of 1929. His conclusion: “You know its time to sell when shoeshine boys give you stock tips. This bull market is over.”
There will be rare occasions when speculation becomes rampant, valuations become hard to justify and the market goes into bubble territory. Such occasions warrant selling. That said, practically it would be difficult to time the selling. Therefore, selling may be done in stages.
When your financial goal is reached
If an investment is made for realizing a financial goal, say, purchase of a house, education of children, creating a corpus for retirement etc., it makes sense to sell the investment and realize your goal. After all, wealth is not an end in itself; it is only a means to an end.
Here it is important to make a difference between realization of a financial goal and fulfillment of a desire. An investor might say that he/she made a particular investment to buy an expensive car/studded jewellery and that he/she is selling now for the fulfillment of that desire. This is perfectly fine from the investor’s perspective. But it may not be a good investment strategy. Many investors have regretted premature selling for fulfillment of desires.
When the fundamentals of the stock change
Business environment changes very fast. In this VUCA world of Volatility, Uncertainty, Complexity and Ambiguity, the pace of change itself has changed. Technology is disrupting businesses like never before. Many bluechips of yester years have become mediocre companies and many have become extinct. The FAANGs – Facebook, Apple, Amazon, Netflix, Google – have disrupted many businesses. Therefore, when the fundamentals that warranted investment change for the worse that would be the time to sell.
When new information warrants a rethink
We make some investments based on some assumptions. For instance, when we make an investment in an upcoming small-cap whose promoters don’t have a long track record to assess, we make an assumption that the promoters would be persons of integrity. This assumption can go wrong. In recent times we had some instances of auditor exits from some companies casting a shadow on the integrity of the management. Such instances warrant a rethink of the original investment idea. Such instances should be used as opportunities to “remove the weeds and grow the plants”.
When not to sell?
When not to sell is equally important, perhaps more so.
Don’t sell on panics
It is well known that fear and greed are the two extreme emotions in the market. As Warren Buffet said, “be fearful when others are greedy and be greedy when others are fearful.” The crowd sells when there is panic in the market. This is the opposite of good investment strategy. During panics the markets crash and sellers incur huge losses. Avoid this mistake. The ideal strategy during panics is not to sell, but to buy.
Don’t sell just because you got very good return
Traders operate with a target price and stop loss. But in investment, target price need not be a good idea. Retail investors have a tendency to book profits too early. Selling a share just because it gave 50 percent return in a year or doubled in two years doesn’t make sense. The share may turn out to be a multi-bagger. In the last 10 years stocks like Bajaj Finance, Eicher Motors, Symphony, Avanti Feeds, Ajanta Pharma, and Relaxo Footwear have multiplied many times (100, 200 and even 300 times) delivering incredible returns. Investment of Rs 9500 in 100 shares of Infosys in 1993 is now worth more than Rs 7 crores. Had the investor exited from these stocks early after reaching a target rate of return, he/she would have lost the golden opportunity to participate in the phenomenal wealth creation these stocks delivered.
Don’t sell during temporary downswings
Even the best of stocks undergo temporary downtrends due to a variety of reasons. If the downtrend is due to structural reasons, it makes sense to sell. If the downswing is due to temporary issues/ cyclical factors, investors should not panic and sell. Wait till the issues get resolved. If you have great conviction in the long-term potential of the stock, the temporary downtrend may be the opportunity to buy.
It is extremely difficult, almost impossible, to buy a stock at the bottom and sell it at the peak. Even masters of the game rarely achieve the feat. But to be successful in the stock market you don’t have to be right all the time. Even in the best of portfolios, there will be poor performers, average performers, above average performers and a few outstanding performers. Wealth is created by the last category.