More important than buying stocks? Selling them

You know you’ve been thinking about it, especially with the S&P 500 cruising past 2,000 and the bull market now six years running: Is it time to sell some stocks and get out ahead of a “market top”?

Here’s the problem: Most information about investing that I’ve read during my career is more instructional about investing in stocks rather than selling them. I think that message has it backward, and that could be why so many professional investors say that selling is harder than buying.

Just like the trigger to purchase a stock, there is no one-size-fits-all when it comes to the sell decision. So here’s the really important thing: Even before one invests in a stock, the basic philosophy underlying when and why to sell needs to be learned. This, I believe, should apply regardless of one’s investment time horizon.

Sergey_P | iStock / 360 | Getty Images

Sergey_P | iStock / 360 | Getty Images

Here are a few things to consider when deciding if it’s the right time to sell.

1. Bogle and Buffett have a point (but only up to a point) about being a long-term investor.

People often think that investing could only mean buying and holding, but that would be a mistake. If someone made money on an investment, it means that he or she would’ve had to have sold it at some point, right?

2. Hesitation is an investor’s most annoying—and often costliestenemy.

If you purchased a stock at $40 and it goes to $60, you might be considering selling it. But if the stock retreats to $55, you might say to yourself, “It was just at $60, so I’ll wait until it gets back to that.”

Then, if the stock goes back to $60, you might say, “It went back to $60, so now maybe it’ll go even higher.” Then, if it retreats to $50, you might say, “I could have sold at $55; I’ll wait for that price.”

And so on. This is a perfect example of where discipline is sorely needed.

3. Breaking even is not the best reason to sell, but it’s a popular one.

Volatility scares investors out of stocks, and selling at break-even alleviates that fear. But it’s generally a trade made for the wrong reasons.

Consider this scenario: People often buy a stock only to see it drop quickly, and they assume they made a mistake, but they don’t want to take a loss. So they wait for the stock to get back to what they paid to sell it. In the end, these sellers often to discover they should have had more confidence in their reasons for buying in the first place: The stock price recovers.

If the reasons you purchased a stock are still intact and the only thing that changes is that the stock declines shortly after you purchase it, then your investment merits patience, not a panicky break-even trade.

4. If you can’t get no satisfaction from stock gains, you’ll suffer pain.

Those who want to wring every last nickel of profit from an investment are destined to give back their gains. It is not possible to know the exact top of a stock or market in advance. You just have to be willing to be satisfied with your gain and move on to the next opportunity.

Making the hard sell a little easier

Do any of the above sound familiar to you? I bet all four. So let’s see if we can do something to improve the selling process.

1. You don’t have to sell all at once.

Whether you are taking a profit or cutting a loss, no one will ring a bell when a stock has reached its absolute peak or nadir. Try selling a stock in increments.

2. Bring some order into your trading life with sell orders.

One method of incremental selling is to use a type of sell order called a trailing stop order. Basically, if a stock that is on the way up declines by a certain percentage, a trigger to sell is pulled. I am going to be honest before getting deeper into this: Reading about this strategy may be headache-inducing for many investors, but it really is worth your time to learn about it—it may make you money or, at the very least, save you some.

It works like this: If your stock goes from $30 to $40, you could enter a 3 percent trailing stop order that would start out at $38.80 (3 percent below $40). If the stock rises to $50, the stop order would rise to $48.50. If the stock then retreats to that price, your sell order becomes a market order, and hopefully you’ll sell at around $48.50. There is the potential that the stock can trade well below $48.50, which means you’d sell at a lower price.

If you’d be unwilling to sell below $48.50, you could also make the trailing order a trailing stop-limit order, which would protect against selling below that level. (You can use percentage gains or dollar gains to implement this strategy. I think using a percentage makes more sense because if the stock goes higher and you are set on a dollar figure, that figure would become a lower proportion of your investment.)

3. Portion control is as good for your profits as for your diet.

You may also use stop orders for just a portion of a stock holding. For example, if the stock goes up 15 percent, put in a trailing stop order for one-quarter of your position. If it goes up 30 percent, put in a new trailing stop order for another quarter of your position. Up 45 percent, do it again, leaving a quarter of the position in your account for the long term.

The advantage of this approach to selling a stock is that the rising sale-price order may potentially help you build more equity without giving back much gain. Another nice thing about using this strategy is that you are still entitled to collect any dividends while you hold the stock.

And remember, trailing stop orders don’t just work when a stock is moving up and you want to take some gains. Instead of just selling a stock that you currently have a paper loss in, you may use a trailing stop order. One would have to be willing to lose a bit more—3 percent in my example—but if the stock starts to rebound, you have the potential to ride the stock higher and have some level of potential protection from further losses.

So if you want to start on your way toward a smarter stock strategy, try implementing these strategies. These key points should help add discipline to your everyday investment activities, and in the end you may be a better investor for it.

Caveat emptor: You should check with your financial advisor on any additional commission costs you may incur using sell orders.

By Mitch Goldberg, special to Goldberg is president of ClientFirst Strategy.

Follow him on Twitter @Mitch_Goldberg