Factors You Should Reckon Before Selling A Stock

There is a vast ocean of material available on buying of stocks but very limited information on when to sell a stock. There’s a great deal of measures talked about identifying the stock and generating a conviction on it, but very rarely do they mention about the exit strategy

In a booming market, like the current one, many profess with a lot of conviction to hold an asset (stock) forever as they’ve already made money. It’s observed that individuals tend to exhibit higher risk tolerance than they possess, when things are moving in their favour and vice versa. So, it becomes imperative to consider the circumstances while assessing risks and its extrapolation to future goals.

“This time it’s different” - A phrase most often used to describe the market conditions especially when elaborating a bull market. We pull out various parameters juxtaposing on each of these details on how this time the market conditions are different. However, this phrase best suits when explaining the market falls. I believe, it’s true that the causes for the next fall would be completely different from the last one. All I’m trying to convey here is that one shouldn’t look through the old prism to understand the new spectrum

There is a vast ocean of material available on buying of stocks but very limited information on when to sell a stock. There’s a great deal of measures talked about identifying the stock and generating a conviction on it, but very rarely do they mention about the exit strategy. Of course, the ideal thesis of holding period of stock is forever but for the individuals with limited knowledge and resources, this could spell doom. Without the exit strategy, one could be like a Abhimanyu in Kurukshetra.

However, one could use the very thesis of buying a stock to check if it’s worth to continue to hold or not. One would’ve done all the research and accordingly have taken a position in a stock but if the thesis/assumptions doesn’t pan out as anticipated or the reality is moving contrary to the story one believed then it’s time to look for an exit. Holding on to a loser when the data is projecting opposite doesn’t help the cause. Giving time is important but it should be in-line with the assumed thesis and one shouldn’t always check the stock price to validate it. There will be times when the price is higher than anticipated but on deteriorating fundamentals.

The other could be check for its history, it could be of the very stock (if it’s old) or the sector or peers if the stock has limited listing past. Basically, one should understand the business cycle and how it responds with the economic cycles. This provides an insight of the expansion and contraction of PE levels of that stock. One could use this barometer to either completely exit or position size the stock within the portfolio. This maynot completely construe to an exit plan but certainly helps to make a choice if another compelling alternative is presented at those circumstances.

Another important trigger could come up due to a merger and/or acquisition. Usually, these happen when the business is extremely good and explore opportunities through inorganic manner. Generally, these actions don’t materialise immediate goals and even the most successful mergers take time to succeed. And at times, the management in its bullish stance could di’worsefy’ into seemingly related or unrelated businesses. The prevailing optimism clouds their decision making, at least from that of your analysis. This is a sign that should trigger for an exit. Personally, I treat any corporate action against the retail or minority shareholders is a sure sign of exit.

The other is when there is deliberate fraud though the initial analysis could filter these companies. Still at times, one could wind up with such stocks, the best is to exit and then contemplate on the enormity. If sold during the early skepticism could turn profitable as the gravity of those revelations weighs down later. Of course, one could also present an opportunity to buy in those situations when the skepticism turns too pessimistic.

These are for those who ‘invest’ while for ‘traders’, a simple stop-loss would do wonders. It’s the best management technique if diligently followed particularly to have a trailing stop-loss in a bull phase. Also, it’s important to distinguish the allocation of short and long-term stocks and employ the methodology accordingly. Ideally, a core and satellite portfolio could be built where a higher conviction stock is placed in the core portfolio while those exploring could be in satellite territory. Nevertheless, one should be open and willing to make amends to this categorization if they move away from the defined investment philosophy.

(The author is a partner with “Wealocity Analytics’, a SEBI registered Research Analyst firm and could be reached at knk@wealocity.com)