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When you purchase a security, you anticipate a certain rate of return. To examine your investment selection’s performance, calculate what you have gained by holding the security:
For bonds, measure the current yield by taking the annual interest pay ment and dividing it by the current price of the bond.
For stocks and mutual funds, calculate the investment’s total return (ending value less beginning value plus income divided by beginningvalue). Visit the several credit-quality Web sites to check the quality rating of all bonds. Read the appropriate annual reports and fund statements for your stocks and mutual funds. Remember that no scientific
formulas exist to guide you in your selling decisions. Knowing some wide-ranging rules and the kinds of questions to ask, however, can help you become a more successful investor. I describe some general
examples of selling rules that beginning investors might find valuable. Veteran investors can have the same selling rules or quite different ones. Regardless of which category you fall into, both new and
expe rienced investors need to choose a personal system and stick to it.
When it’s time to sell, consider using a stop-loss order — also called a stop market order You can place a stop-loss order to sell when a certain price is reached. Its purpose is to limit your
loss on a particular secu rity. For example, you can set a stop-loss order for 10 percent below what you bought the stock for to limit your loss to 10 percent. For investors who are unable to watch their
portfolios for an extended period of time because of holidays, vacations, and so on, this order can be a tremendously useful tool.
A sure way to lose big money is to hang on to an investment that’s losing money. Try not to involve yourself emotionally with your investment selec tions. One way to lower the likelihood of holding on to
an investment for too long is to develop a few personal selling rules. Write your personal selling rules in your investment plan and store the plan on your computer’s hard drive. If you’re thinking about
selling an investment, use these rules to com pare your current state of mind with what has worked for you in the past. Your personal selling rules may state, for example, that you should sell the stock if
any of the conditions in the following sections occur.
The stock drops below your predetermined trading range
This selling technique is called scaling out. In other words, it is a structured selling method based on your predetermined trading range. For example, you can sell stock at predetermined levels as it goes
up, say 20 to 25 percent of your investment at a time, securing profits along the way. Each time you sell 20 to 25 percent, the average cost of the stock remaining decreases, protect ing you from the effects
of a sudden possible decrease in the price of the stock. Some industry experts suggest selling any stock that increases by 30 percent above the original purchase price. In contrast, sell the stock if it drops
below 10 percent of the purchase price.
Before you sell it, however, remember why you purchased the stock in the first place; then find out what changed and how it affects your portfolio. In the past, maybe the company was a market leader or
the company had a new technology. Perform a post-sale analysis of the stocks that plan you sell. Determine the best time for selling by examining the tax consequences of your actions. For more about
how you can avoid profit wipes-outs due to capital gains taxes, see the last section of this article.
You discover that the company’s relative strength is flat or trending downward Relative strength is how the company compares with the market or operates in the current market environment. (When researching, you often discover the relative strength number calculated for you.)
Check out the relative strength of the stock’s performance over the latest 12-month period. Compare this number with other stocks’ numbers to determine whether your stock is a loser. Low rel ative
strength ratings are often the first red flags for sell candidates. The rating scale is between 1 (lowest) and 99 (highest). Stocks rating 70 or lower may be laggards and potential sell candidates.
You recognize that the industry is in a serious downturn To recognize a downturn, you must watch the company, the industry, and the sector rather than just the stock price. Management changes can also adversely affect stock prices. Sell the stock if the
company shows signs that it may not produce the earnings or sales growth you originally expected when you purchased the stock.
You determine that the company is in declineEven great companies are cyclical — that is, they have up periods and down periods. Sometimes you can purchase shares at bargain prices, and other times you buy shares that are overpriced. In general,
all companies are affected by the economy and have selling cycles. Some stocks trade with a low P/E ratio even if the company is earning money. These low P/E ratios indicate that investors fear the
company’s earnings will decline. These fears, which may be
based on new competition in the marketplace, can also adversely affect earn ings growth and long-term prosperity. For example, does the company rely on one single product whose life cycle or patent
may be running out? If so, con sider selling this stock and replacing it with a similar stock that has more promise.
You discover that the company’s profitability or financial health is in trouble
If profit margins and the financial structure of the company seem to be weak ening, you should consider selling. That is, sell if the stock shows below-average profitability compared with the industry
standard or other selling standards based on the firm’s financial statement. For example, determine whether the stock has three years of earnings that are up 25 percent or more and a return on equity
ratio (ROE) of 17 percent or more. Use a selling stan dard that meets your required rate of return. If the stock doesn’t meet your standards, sell it.
Market experts call the company “steady” or dividend increases are behind the general market
Some investors seek earnings growth (net income for a company during a spe cific period, usually after-tax income) of at least 10 percent per year. Determine the amount of returns you can expect over the
next five-year period. Make your best estimate of earnings and discount them heavily if you expect the market to be depressed. Keep in mind that, because of market volatility,
your estimates may be subject to big errors. Compare your results with your own required rate of return (which is different for each investor). Is the stock worth holding if that’s your potential gain? If not,
it’s time to sell.
Company insiders are selling in the public marketplace
Insiders are individuals who own 10 percent or more of the company and are required to report all their company stock trades. If insiders are selling their shares in the company or if the company is
purchasing its own shares — both activities that may indicate future financial problems — you might want to sell.
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