Here’s the art of selling your stocks at the right time | Mint – mint | Candle Made Easy

Investing in stocks is all about identifying and buying a good stock, holding it for a long enough time, and selling it when the time is right. The third part of this process – selling the stock generally doesn’t get the prominence it deserves, which in turn leads to subpar returns in the markets, even with good stock calls.

For investors with a reasonably long-term horizon, there are five scenarios in which they should sell a stock. First, the stock theme has caught on, the fair price has been reached and the stock price has even overshot. Undoubtedly, the fair value estimate will need to be partially revised upwards as circumstances change. However, holding the stock even after exceeding the revised fair value indicates a poor investment process and behavioral biases. Second, one realizes that the purchase was a mistake – the constructed stock theme was flawed, too aggressive, or based on incorrect assumptions. Diligent investors regularly do this exercise to challenge their own thesis. They keep questioning the reasons for investing in their core holdings to avoid being caught off guard. Sometimes this exercise throws up some strong counterpoints, some of which may lead us to conclude that our decision was wrong. Once this mistake is recognized, one must admit and recklessly exit the position. Hoping that fortune will turn or some unforeseen positive factor will materialize can damage our wealth in the long term.

Third, changes in a company can be a reason to sell the stock. For example, a change in top management or an unrelated merger or acquisition, or a company’s decision to exit a company, may affect the fair value of the stock. Another reason can be a change in the environment after the stock purchase. For example, any changes in regulatory or policy measures that adversely affect the business. If a few well-funded and aggressive players enter the market and a price war erupts with no end in sight, the stock’s prospects can also cloud over. Finally, if a compelling opportunity has arisen elsewhere and we need to allocate funds to other stocks that require us to sell some of our existing holdings, we should consider doing so.

So what are the factors preventing us from carrying out a planned and orderly sale at the optimal price level? The most common, largely behavioral, are as follows.

Sunk cost misconception – as human beings we all suffer from loss aversion. Therefore, even if the prospects are poor, we do not dare to sell a share if it is below its purchase price. In our ego trip that keeps us from taking losses, we fail to realize that the decision to sell or hold a stock should be made solely based on its future prospects. It is important to remember that the purchase price is a thing of the past, cannot be changed and is a sunk price. Therefore, the decision to sell should be absolutely independent of the purchase price.

Misinterpretation of the long-term investment horizon – The investment horizon is one of the key elements of a fundamental investment process. However, some investors end up using it as a place to hide from their mistakes. If a stock’s future prospects have deteriorated and it’s becoming increasingly clear that buying the stock was a mistake, then not taking action now by claiming that a long-term investor is a mistake can lead to the stock not taking action. Patience is essential in investing, but not when a mistake has been spotted.

Getting married to a stock – many investors take the “own a company, not a stock” adage to extremes and lose their objectivity as investors. Because they love the company’s product too much and are too impressed with management, they fail to see any clear signs of an irreversible erosion of the company’s competitive advantages or an unjustifiably wide stretching of the stock’s valuations. This cognitive bias, known as the endowment effect, disturbs even savvy, seasoned investors.

Hope for continued momentum – some investors hold on to a stock even when its price target has been met and valuations are stretched. Here is hope that price momentum will continue to support the stock rally. This ends up being what it planned – just a hope, devoid of logic and fundamental analysis.

Vipul Prasad is the founder and CEO of Magadh Capital LLP.

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