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3 Reasons to Sell Your Stocks

Photo credit: Rafael Matsunaga. Licence: http://creativecommons.org/licenses/by/2.0/

As an avid stock market investor, I have read numerous books on investing and what to look out for in a company. Many of the books I have read emphasise the importance of buying the correct stock at the correct price.

However, knowing when to sell a stock is equally important. This can sometimes be overlooked by investors who put too much effort into researching a company, but do not know when is the correct time to take a profit or cut losses.

As a long-term investor myself, I usually buy a stock with plans to hold it for an extremely long time. But there are still some reasons that would make me want to sell my position in a particular stock. Below are three reasons to sell your shares.

Reason 1: When the stock price exceeds the company’s fair value

Benjamin Graham, the legendary investor and author of the classic investment book The Intelligent Investor, once said that the market is a voting machine in the short run, but a weighing machine in the long run.

This means that there is a possibility that the price of a stock can go beyond its fair value at any point in time if investors become too optimistic about its prospects.

One good example is the 1999 dotcom bubble, when prices of Internet-related companies skyrocketed. This led to many companies being priced at 100 times their earnings or more. Obviously, this was not sustainable, and the prices of those companies came tumbling down when the bubble eventually started to collapse in 2000.

Even if we believe we have bought into a stable company with solid business fundamentals that we wish to hold for the long-term, we should still monitor the stock price of the company. If the price starts climbing way beyond what we would consider a fair value, we should seriously consider selling our position.

Reason 2: The company’s fundamentals have changed

It is important that we put in a good amount of time to study a company’s background before we make any investment decision about its stock. However, even if we do solid research and end up investing in a company’s stock, there can be times when the company may run into permanent trouble down the road, causing a change in our investment thesis.

There are many factors that can affect a company’s business. These can include new disruptive technologies that may completely change the business climate, or it could also just be new competitors fighting for market share. Changes in the company’s management team could also affect business results going forward – such changes are especially important to watch if the main reason for investing into the company is its strong and dependable management team.

We need to be aware that changes can affect the profitability of a company and can thus materially affect our investment in the long term. If so, then we may need to consider if it may be time to sell.

Reason 3: If we have made a mistake

“We all make mistakes. If you can’t make mistakes, you can’t make decisions.” – Warren Buffett

Everyone makes mistakes. Even billionaire investor Warren Buffet has admitted on numerous occasions that he has made mistakes. In investing, there are two broad categories of mistakes: They are mistakes of omission, and mistakes of action. The former occurs when you should have bought a stock, but did not for some reason. The latter is when a stock you’ve bought turns out to be a mistake.

Since mistakes are unavoidable, what is more important is learning from a mistake and rectifying it as early as possible.

Too many times, investors, myself included, realise our error but refuse to take action. One example could be holding on to a stock that is declining in value. As we have already lost money on it, we may decide to wait a while longer in the hopes that the share price increases. This can be because of ego or because we refuse to take any losses on our investment.

The Foolish bottom line

The best way to invest in the stock market is usually to invest for the long term. If possible, we should look to hold our stocks indefinitely. However, there are still situations in which selling is the right step to take. Investors who manage their own portfolios need to be able to identify the situations when selling makes more sense than holding.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn’t own shares in any companies mentioned.