You never want to sell a stock at a loss, if you can help it. However, you also don’t want to hold onto a stock too long and watch your losses get bigger. It can be difficult to decide when to cut your losses and sell. Especially during times of extreme volatility and market recession. The first important step is to try and take emotion out of the equation. Additionally, you should watch for some tell-tale signs that a stock is heading down in value. If possible, the smart move is to sell before things get really bad. Here are six signs that it’s time to sell a stock you’re holding.
The Price Drops 10% to 15% From a Recent High
Professional traders use all kinds of matrix and tools to evaluate when a stock has peaked. For individual traders who do not have access to such sophisticated tools, you can watch for one simple sign. When a stock’s price falls 10% to 15% from a recent high, take notice. It’s a clear indication that a stock’s price has peaked. It can also be a sign that it may have been overvalued to begin with.
The true value of the stock is likely somewhere below that peak. Keep an eye on a stock’s price. Be sure to set a stop loss order around 10% below a high. If a stock is trading at a peak of $300 per share, set a stop loss order at $270. That way if the share price falls 10% or more, you’ll liquidate your position. That gets your money out before it falls any further. Remember, it’s never a good sign if a stock price falls more than 10% to 15%. The red warning light should be flashing at that point.
The Sector is Experiencing Volatility
The shares of any company tend to belong to a particular sector of the economy. Apple, for example, is part of the technology sector. Starbucks belongs to the food and beverage sector. American Airlines is part of the airline sector, and the transportation industry, more broadly. Often, a particular sector can experience volatility all at once. That sends share prices down for all companies that are part of that sector.
Higher oil prices, for example, can negatively impact the airline sector because it consumes huge amounts of fuel. A trade war between the U.S. and China can negatively impact technology companies. Most of them manufacture their smart phones and computers at Chinese plants. When volatility comes to a sector, it typically hits shares of all the companies within.
If you see an across-the-board price drop in companies of a particular sector, take heed. It might be a sign that you should sell your position in a stock before it gets dragged down with the rest of the sector. Few stocks are immune to sector shocks and broad-based pull downs.
Executives Are Selling Their Stock
It may sound a little cynical, but another sign to watch for is whether executives are selling stock in a company they work for. When management starts selling their own holdings, it usually indicates that they anticipate the share price to drop in the near future. This can occur for any number of reasons. It might be a poor quarter, declining sales, increased competition, and so on.
What you can count on is that the top level leadership knows more about the status of their business than you do as an outside shareholder. The disclosure requirements for publicly traded companies are only semi-useful. The information is usually only revealed every quarter, concerning the buying and selling of stocks by company insiders. So, when those leaders are dumping stock, it might be a sign that you should too. At the very least, you should issue a stop loss order to protect yourself in the event of a serious drop.
The Company Cuts or Suspends Dividends
Companies that are profitable tend to pass along those profits to shareholders in the form of quarterly dividend payments. However, in tough times, companies will sometimes cut their dividend payments. Or suspend them altogether as they hoard cash and plow it into their struggling operations.
If you’re invested in a company that has paid regular and reliable dividends and they suddenly announce that those dividends are being reduced or stopped altogether, it’s definitely a bad sign. You can bet that the share price will fall soon. Cutting or suspending dividends is one of the most obvious signs that a company is in trouble. Negative changes to dividends almost always prompt a sell off and further decline in share price. Be wary of such a move.
Multiple Analysts Downgrade The Stock
Analysts aren’t always right. Individual experts often take contrarian points of view on a company and the direction they see its stock price heading. However, when multiple analysts downgrade a stock and recommend you sell, you may want to pay attention. Whenever you have many analysts singing from the same song sheet, it’s usually a sign that a stock is in choppy waters. The share price is likely to trend lower.
Several sell recommendations alone can be enough to depress a stock’s price. While you don’t have to pour over individual analyst reports, you should keep up on the news related to companies you own shares in. If you see that analyst downgrades are occurring with more frequency, you should heed it as a sign that it may be time to dump your holdings.
The Stock is Being Shorted
Shorting a stock is a trading strategy that speculates on the decline in a stock’s price. It’s an advanced strategy that is typically only used by experienced traders and investors. It basically means that investors are betting that the share price will fall.
A few months ago, Tesla stock shot up from $400 a share to over $900 a share. Fantastic, right? However, as Tesla’s share price peaked, it became the most “shorted” stock in the world. That meant that an overwhelming number of traders were anticipating that the share price would start to finally fall. The consensus was that Tesla’s stock was overvalued to the extreme. Some investors were trying to make money on the stock’s decline in value, rather than its appreciation.
Sure enough, Tesla’s share price recently traded back under $400. If you find out that a stock you own is being widely shorted by experienced traders and investors, watch out. It can be a sure sign that a depreciation in value is coming. You may want to get out while the gettin’ is good.
The Company Misses its Quarterly Financial Results
Few things will cause a stock to immediately and swiftly fall as much as an “earning miss.” Publicly traded companies are required to issue financial results every three months, or four times a year, and analysts who cover the stock have targets in mind for how much revenue and profits per share a company should post for each quarter. Companies help inform the analysts expectations by issuing forward guidance on the earning they expect to produce each quarter and for the full year.
When a company posts financial results that are better than expected, a stock tends to rise. However, when a company posts worse than expected quarterly or full-year results, a stock’s price typically falls. And once a company disappoints with several consecutive quarters of worse than expected results, a stock’s price tends to go into a nosedive. So, pay close attention to the financial results of any companies whose stock you own and be prepared to sell if they miss badly on a quarter, and especially if they disappoint multiple times.
The Stock is Declining in Value (While its Peers Are Rising)
Stocks of certain sectors tend to rise and fall together. Bank stocks, for example, tend to all move in the same direction. When one rises, so do they all. The same goes for stocks of airlines, clothing retailers, automakers, etc. So, it should be seen as a red flag any time a stock is out of synch with its peers. If all bank stocks are rising and the bank shares that you hold in your portfolio are declining, you need to investigate why.
Often a particular stock can move in the opposite direction of its peers because of poor financial results, too much debt, an analyst downgrade or a management shake-up at the top of a company. Internal issues at a company can end up sending that company’s stock moving downward when its peers are rising. Regardless of the reason, you will want to find out why a stock you hold is falling and determine if it is a minor, short-term issue that is likely to correct itself or indicative of bigger problems that should prompt you to sell the shares you own.
The Company is in Hot Water With Regulators
Any time the phrase “under investigation” is used in relation to a company, you can bet that it will send the stock into a tailspin. Markets hate uncertainty and few issues cause more clouds to form over a company than an investigation by regulators. Regardless of the reasons, anytime a company runs afoul of regulators, it is cause for concern and will surely depress the stock price.
Regulatory investigations can have a dampening effect on a stock’s price for a long time as investigations tend to drag on and the timeline for a resolution is not clear, creating considerable uncertainty for a company and its shareholders. Often, a stock’s price will jump higher once regulators conclude an investigation and announce that they are fining a company or taking other punitive actions. This is because the uncertainty surrounding the investigation is now lifted.
The Company Revises Down its Forward Guidance
Probably the only thing worse than a company missing on expectations for its financial results is when a company downwardly revises its forward guidance. Stock markets, by their nature, are forward looking. Analysts say that the stock market tends to look out nine months from the present and react to potential news and issues anticipated in the future.
So, when companies say that they don’t think they’re going to do as well as expected in the future, the stock takes a hit. If a company revises its guidance down for several quarters in a row, or for the full year, saying it expects to earn less revenue and profits than previously estimated, it can be a sign that the company is in financial straits. Investors will want to be quick to hit the “sell” button if it becomes clear that a company is in trouble and its stock price is reacting negatively to the news.
More Stock is Issued
Companies raise money by issuing stock. When a company needs cash or is experiencing financial difficulty, they will often issue more stock to raise funds. However, more shares sold ends up diluting the value of the existing stock held by shareholders. In essence, the stock become less valuable the more of it is available on the open market.
For this reason, a stock’s price often falls when a company announces that it is issuing more stock for sale to the public. Existing shareholders are usually angered by this news and sell their holdings. And if a company sells more stock frequently, it can be taken as a sure-fire sign that the company is having financial problems. Conversely, when a company buys back its own stock, it makes the outstanding shares more valuable and the share price tends to rise.
Media Reports Say the Company Will File For Bankruptcy
The word “bankruptcy” is like a death knell for a stock. Even a rumor that a company might file for protection from its creditors is enough to tank a share price, and it is unlikely that the stock will recover. Before the Covid-19 pandemic struck in March 2020, the stock of Hertz rental car company was trading at just over $20 a share. After the company filed for bankruptcy in May 2020, the share price fell to just $0.41.
Should you hear that a company whose stock you hold is considering a bankruptcy filing, it is a sign that you should immediately sell your shares. Big institutional investors will dump the stock and that will send the share price plummeting. Don’t wait around hoping for a miracle or a reversal in the share price. Sell and get out before your losses worsen. You’ll be glad you did in the long run.
The Bottom Line
Just as there are lots of reasons to buy a stock, there are also plenty of reasons to sell a stock. Investors should remain vigilant and always pay attention to what is happening to their holdings. When a stock falls, the first step should always be to find out what is happening and why a share price is depreciating. From there you can determine if it is worth holding onto the stock and riding out the downturn in hopes of a turnaround or sell your position, take any losses, and move on, a little wiser for the experience.
In the end, the important thing is to be realistic and practical when it comes to your investments. Remember that the best investors are ruthless when it comes time to sell a stock. They hit the “sell” button as quickly as they hit the “buy” button.
Shutterstock
