When Do I Sell?
The Dynamic Wealth Report
January 21, 2010
by Robert Morris, Editor
I get this question from subscribers all the time. It’s probably the
question I receive most often.
And, I understand why.
Knowing when to sell an investment is one of the toughest skills an
investor has to master. But, it’s a critical skill to have if you want
to make money in the market over the long run.
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Prior to the tech bubble of the late 1990s and early 2000s, most
investors followed a buy and hold approach. All they had to do was
continually invest new money in the market and watch it grow.
Very little thought, if any, was given to the question of when to sell.
The conventional wisdom at the time was to hold your investments until
you reached retirement age. At retirement, you’d start withdrawing money
from your investment portfolio to live on.
But, everything changed when the tech bubble burst in early 2000.
Retirement savings, 401ks, and pension plans were all decimated. Decades worth of savings were literally wiped out in the blink of an
eye.
Many of you probably remember.
The S&P 500 peaked in March 2000 at 1,553. Over the next two years, it
declined steadily suffering violent day to day swings. The index finally
bottomed in October 2002 at 768. When all was said and done, the market
had lost more than 50% of its value.
But that wasn’t the worst of the carnage.
The NASDAQ suffered an even worse fate. The tech heavy index fell from a
peak of 5,132 to a low of 1,108. That’s a whopping decline of 78%!
Many investors lost everything they had.
But, it didn’t have to work out that way.
If they had merely employed a simple sell discipline, they could have
avoided the investor’s worst fear… the catastrophic loss.
A sell discipline is simply a strategy for when you will sell all or a
portion of any investment. It’s a set of rules defining the
circumstances or conditions under which the investor will sell.
Why is a sell discipline necessary?
It’s necessary because human beings often let emotions get the best of
them. And, when our emotions take over, we tend to make bad decisions.
The two emotions that plague investors most are fear and greed.
As an investment climbs in value, nearly every investor will at some
point get greedy. They’ll know the investment is overvalued and ripe for
profit taking… but, they’ll hang on believing it will only go higher.
Fear takes over when an investor is sitting on a loss. They’ll know the
investment didn’t work out and should be sold. But, they hang on to it
because they’re afraid of taking a loss. Inevitably, the investment just
continues going down and the investor loses a lot more money.
The investor who uses a sell discipline can avoid being done in by their
emotions.
So, what sell discipline should you use?
Unfortunately, there’s no single right answer to this question. A sell
discipline is a personal strategy that each investor must develop for
themselves. There’s no one size fits all.
You see, every investor has different goals, time horizons, risk
tolerances, and financial situations. The best sell discipline is the
one you develop for yourself taking these various factors into
consideration.
With that said, here are some key elements to a successful sell
discipline.
- Establish your reasons for the investment. Whether you use
fundamental or technical analysis, you should know exactly why you’re
investing in any particular security. As soon as you see conditions
change for the worse or something unexpected happens, it’s time to sell
and look for better opportunities.
- Set an upside price target. This is critical for knowing when to take
profits off the table. Before you invest, decide how high you think the
investment can go over your time horizon. You can use fundamental and/or
technical analysis to calculate the target. You probably won’t get out
at the peak every time, but you’ll lock in more profits if you have one.
- Decide where you’re going to exit if the investment goes against you.
This is essential for limiting losses on investments that don’t work out
as planned. Many investors use a mechanical sell discipline… they’ll
exit if the investment drops by a certain percentage from their buy
price. Others use technical analysis to identify critical support levels
that signal a sell when breached.
These are just a few key elements to a successful sell discipline. You
can certainly make yours more detailed and elaborate. The more concrete
your sell discipline… the more effective it will be.
Start developing your sell discipline right away. Free yourself from the
psychological prison of fear and greed. You’ll suffer a lot less stress
and have better success with your investments.
Major market indices are falling sharply for a second straight day.
Concerns about China’s economy slowing, potentially harsh regulation of
U.S. banks, and a debt crisis in Greece are weighing on markets around
the world. As a result, leveraged inverse ETFs are breaking out all over
the place. Direxion Daily Emerging Markets Bear 3X Shares (EDZ) is up
8.6%, UltraShort FTSE/Xinhua China 25 ProShares (FXP) is up 6.9%, and
UltraPro Short S&P 500 ProShares (SPXU) is up 5.7%.
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