Although many factors can lead you to sell a stock, it’s a good idea to have some kind of numerical rule of thumb for ridding your portfolio of stocks that are losing or will become losers.
Many investors tend to sell a stock when it is high in value. If a stock starts falling in price, they hesitate, wanting to wait until it recovers. This strategy can leave an investor with a portfolio full of poor stocks.
A better strategy is to set guidelines for when you will sell, and stick to them. Decide ahead of time which contingencies will cause you to dispose of a stock. Two rules of thumb used by investors are: (1) sell when the company’s earnings for a 12-month period go below the earnings for the previous 12-month period; and (2) sell when a stock’s price falls by more than 10%.
Another contingency that might cause an investor to sell is that the reason a stock was bought no longer applies.
For instance, suppose you bought shares of Plum Software because it was launching a new product that promised growth for the company. You find out a few months down the road that Plum’s plans have fallen through. That is the time to sell. You bought the stock for growth, and no growth is in the offing, so there’s no reason to keep it.
Although rules of thumb cannot guide you unequivocally through the stock market, they may save you from taking some big losses.