Let Sensex hit 8K, but sell at the right time or lose

SANJAY MOOLCHANDANI- The Economic Times: "Fear of making another mistake (the first one was buying a stock that dropped in price) often keeps investors from cutting their losses before they become big losses. This is one of the emotions that influence judgement when investments don’t work out the way one hope. While that’s a great attitude for life, but it shouldn’t influence one’s thinking or obscure the obvious.

Here’s what happens way too often: An investor invests Rs 10,000 in a stock when Sensex is just not willing to stop its surge. The investor is hoping for a nice return. Instead a correction happens, which analysts say is due for long, and the stock turns the investor’s Rs 10,000 investment into say Rs 5,000.

The investor suffers a 50 per cent loss, but still holds on hoping the Sensex will move higher and the stock will earn her money back.

What are the odds this is going to happen?

Not good, if you think about the math, the stock will need a 100 per cent gain to get back the Rs 5,000 loss.

Do stocks record 100 per cent gains? Sure, but not that many and it usually takes a long time.

Experts say that the way to make money in the market is to not lose it. That is not to let losses become big losses that will take a long, long time to recoup.

So how do you decide when to sell stocks?

The answer to this question is not easy. One needs to have a clear financial goal and understanding of its risk appetite along with stock market know-how to make this decision.

No body can predict correctly in the stock market all the time. But one can reduce losses by following some of the fundamental rules of the game.

The best way to know when to sell a stock is to know why you own it in the first place.

Did you like the company's fundamentals? Then you should know when they are changing for the worse. Was the company the industry leader? Then you should keep a close eye on the competition, and know when it is catching up.

Did you buy the stock because it was undervalued? Then you should have a firm idea of what you think fair value is.


Here are some pointers which can help you to take the decision to sell or not are given below:

* The stock loses by ‘x’ per cent

If you buy a stock you may set an arbitrary floor for the stock. When the stock falls to this floor, you sell. The floor can be set at anywhere between 6 and 10 per cent range, depending on the volatility of the stock. You may not be happy about a small loss, but this makes sure it doesn’t become a big loss.

* The company tumbles

This is a signal to sell. You bought the stocks because of the company’s good fundamentals. When something changes and the company loses its way, the investor has to re-examine whether it is the right choice any more. A change in management, or continuous losses or continuous reduction in revenue could be a good indicator.

* When a stock is over-valued

When stocks increase enough to pass their true value, they are often set up for a fall. The strategy is to sell when they are over-valued and buy them back after a market correction has knocked the price back down. This, of course presumes an accurate knowledge of the top and bottom of prices. Selling an over-valued stock is certainly preferable to buying an over-valued stock.

* Selling based on price

Investors often pick up a stock with just average fundamentals but which is clearly undervalued. If you buy a stock not because you love the company, but because the stock is cheap, then you should keep a much closer eye on valuation. Unfortunately, no hard-and-fast rule exists on when a stock becomes too expensive. Simple rule-of-thumb might help such as P/E or PEG ratios. A stock is under-priced if its PEG falls much below 1, and overpriced if the PEG is much greater than 1.

* The stock becomes too large a part of your portfolio

Any time a stock grows to become more than 10 per cent-15 per cent of your portfolio, you should start thinking very carefully about how much risk you're taking, even if you still think a company has great prospects. It's simply not prudent to allow it to take up too large a percentage of your portfolio. Surely, diversifying should apply to more categories, such as sectors, market caps, and styles, in addition to individual stocks. Any time you find that too much of your portfolio is in one area of the market, its time to sell some part of it.


* Risk tolerance reached

You bought a company that looked like it will have a steady growth, but instead it has turned out to be a roller coaster ride. For whatever reason, this stock is just too volatile for your nerves. Dump this and replace it with a stock that will let you sleep at night.

* You’ve reached your goal

Once you have reached your financial goal, whether it was retirement or sending your child for higher studies abroad. This is the time to start systematically liquidating those stocks you’ve tagged for this goal. If you have been trading, make sure you have owned the stock at least one year before selling so it falls under long-term capital gains tax rules.

There may be other reasons to sell that are just as valid as these are. Always consider the consequences (transaction costs, taxes, etc) before making any decision to sell. "