Thinking About Selling Stocks? Consider This First

by: The Financial Lexicon

A reader recently asked me to share some thoughts on selling securities after large run-ups in price. In this article, I would like to address that topic by focusing on common stocks. As you consider whether to sell a stock or index fund that has appreciated in value, it is important to think about why it is you own the stock/fund and what role that stock/fund plays in your portfolio.

Trading - If a stock you own for a trade has appreciated in value, the decision to sell will likely be based on your price target, technical analysis, and/or whether something has changed in the story behind the rising share price. Such a change could be as small as a slowing in the future growth rate of earnings or as large as a major corporate announcement that takes everyone by surprise.

Moreover, when trading, do not be afraid to wind down a position in pieces. High-fliers like (NASDAQ:AMZN) or Netflix (NASDAQ:NFLX) often trade at valuations that seem insanely expensive. But it doesn't mean they can't go higher. Momentum is a powerful force in a stock market dominated by short-term-oriented thinking. When trading stocks like Amazon and Netflix from the long side, I think it's a good idea to sell in pieces. Far too many investors incorrectly called tops in Amazon and Netflix far too many times. As a trader, breaking your allocation into halves, thirds, or even quarters, and selling a little at a time on the way up, is one way to prudently manage a position without calling a top. And the same strategy works in reverse. Stocks like Amazon and Netflix are momentum-driven dreams for Wall Street's traders. When the time comes to sell them, if you jump on the bandwagon and get short, you can use similar considerations for exiting the position as you would from the long side.

Long-Term Capital Appreciation - Equities owned in order to capture significant capital appreciation can certainly be sold well before your definition of the "long-term" is met. If a stock you anticipated doubling over a five-to-ten-year time frame suddenly does so in two years, there is no shame in selling.

One example from my portfolio is Manpower (NYSE:MAN). I purchased half a position on August 10, 2011 at $39.25 and the other half on September 6, 2011 at $36.12. My assumption was that from those prices, I could realize 10% annualized returns for a number of years. But after more than doubling my money in just over two years, in mid-October, I decided it was time to sell the position. I didn't own those shares for the dividend (income was just a very small side benefit). Instead, I primarily owned those shares for capital appreciation. The decision to sell was based on my investment objectives rather than a definitive statement on whether I think the stock can go higher. And I arrived at that personal decision after thinking about why I owned the stock, the role it played in my portfolio, and what it had achieved in such a short period of time.

Long-Term Income Appreciation - Stocks that are held for income-generating purposes are perhaps the least likely to be sold, even when there are massive gains in share price. Two examples from my portfolio are Bristol-Myers Squibb (NYSE:BMY) and Raytheon (NYSE:RTN). Each of these stocks has more than doubled since I acquired shares in 2011. But unlike with my former Manpower position, I have no intention of selling Bristol-Myers or Raytheon anytime soon. I primarily own these stocks for the dividends and for potential future dividend growth. Despite the possibility of the unrealized gains I currently have disappearing, at this time, especially given today's interest-rate environment, I am reluctant to give up those income streams. As in the Manpower example, I arrived at the decision to hold Bristol-Myers and Raytheon, rather than booking profits of more than 100% after thinking about why I own the stocks, and the roles they play in my portfolio.

On a final note, investors using stagnant stop-loss orders or trailing stop-loss orders as a method of discipline for exiting a position should be mindful of the following: Sometimes stocks "gap" lower by significant amounts. If a stock gaps down from, say, $40 per share to $35, and you had a stop-loss order entered for $39, you are going to be very disappointed when your sell order gets filled around $35. Should you decide to hold a stock you are considering selling through a major expected corporate announcement (such as an earnings release), consider canceling any open stop-loss orders prior to the announcement. After the announcement is made, place new stop-loss orders at prices that make the most sense, based on the recent information delivered by the company and the most recent share price performance.

Disclosure: I am long BMY, RTN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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