Buying a stock requires some amount of skill.
What investors forget is that selling the stock too requires intelligent thought.
Knowing when to sell is as important as knowing when to buy.
When the stock price soars, the decision is easy. Sell at a profit and grin at your success. What happens if the share price does not rise and instead, drops.
That's when you need to be smart. Here are some tips on how to get it right.
Never hang on to a losing position.
Try to figure this one out: A stock that declines 50% must increase 100% to break even!
Let's say you bought a stock at Rs 50. Instead of rising in value, it falls by 50%. Now it is worth Rs 25.
Now the stock that is worth Rs 25, will have to double in value to touch your original cost price of Rs 50. So, it must now rise by 100% to touch Rs 50. If you still want to sell it at a profit, you will have to expect a rise higher than 100%.
Got it? If a stock drops by 20%, it will not have to rise by the same percentage to break even.
Here's what it requires for your stock to get even, in case it falls by a certain percentage.
|
Percentage fall |
Percentage rise required to breakeven |
|
10% |
11% |
|
20% |
25% |
|
30% |
43% |
|
40% |
67% |
|
50% |
100% |
A stock that comes to mind immediately is Blue Chip India Limited. In June 2004, it was around Rs 22. Today, you can sell (or buy) it for around Rs 4.
Decide whether to sell or hold
There is absolutely no guarantee that a stock will ever come back. In fact, waiting to break even - the point at which profit equals losses - can seriously erode your returns.
On the flip side, it does not mean that rebounds do not occur.
Sometimes a stock's price has been unfairly hammered. You may be willing to wait for the turnaround, which sometimes could be around three to five years.
Take the case of Nuchem Ltd. On January 1, 2004, its price was Rs 3.80. Within two months, it was Rs 1.90. But, by September 2005, it was Rs 16 and then dropped to Rs 8.
So you can hold or decide to put your money to work in a better way by investing it in a winning stock.
So how do you make the choice?
If you bought a stock because your friend said it would soar, you'll have trouble making the right decision.
That's why you must do some amount of research before you invest in a company.
Did you buy a company because it had a solid balance sheet?
This leads to the next question.
Has the reason you bought the company changed? If a stock has gone down in price, there is usually a reason for it. Unless of course, there is a change in the overall market. For instance, if the Foreign Institutional Investors all pull their money out and the market dips or sudden political instability affects the market sentiment.
Is there a fundamental change in the company? Are there any events which could potentially diminish the reasons behind the investment. If after some research you see the same characteristics as before, hold on to the stock.
If there has been a change, then ask yourself if the change is such that you would not buy the company again? For example, does it alter the company's business model? If so, it is better for you to sell the stock as its business plan has greatly diverged from the reasons behind your original investment.
Be cold and calculating
When the dotcom bubble burst in 2000 and the market started its descent into a bear market, investors froze like deer caught in oncoming headlights.
Many didn't even react until the value of their portfolio holdings had declined by as much as 50-60%
Remember never to get emotionally attached to the stock. A detached view will help you make smarter decisions.
Ultimately, it all boils down to three basic questions
Why did I buy the stock?
What has changed?
Does the change affect the reason to hold?
Answer these honestly and you should do alright.
More from rediff