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How do you know when to sell a stock?

For every successful transaction you perform in the equity market, there are 2 steps; the first is to invest in a good stock and the second being to sell the equity in the market at the right time. A lot of amateur investors do this mistake of not paying attention to the second part. It is equally important that you find the right timing to sell your stock, unless you do that you won’t be able to reap off all the profits that you deserve while putting in the hard work of choosing the right stock.

It is extremely important that you perform a proper technical analysis when you’re exiting from the stock market. As a firm, William O’ Neil believes that successful investors aren’t formed overnight, they practice and work harder each day. They go by the methodology of “Always cut short, limit your losses”. This requires immense discipline and you can learn it over time.

If the market is in a downtrend and your stock isn’t performing well, it is extremely important to act rational and not let emotions get the better of you. Successful investors never hold on to big losses because they understand losing small and winning big is the holy grail of investing.

When you’re holding on to a big loss, you’re rarely able to think straight. You get emotional. You rationalize and say, “It can’t go any lower”. But, keep in mind that, the stock price can go to zero as well.

MarketSmith India believes that to understand the question of ‘When to sell’, one first needs to understand ‘Why to sell?’. There are 3 main reasons for selling a stock:

  1. Protect Capital
  2. Lock in Profits
  3. Distribution in the general market

Protecting Capital:

The general basic mathematics shows that as the losses increase, it becomes more difficult to break even. A loss of 10% means that you need a gain of 11% to breakeven, a loss of 20% needs a 25% gain and a loss of 50% needs an enormous gain of 100%.

It can be clearly observed that as the losses increase, it becomes more difficult to break-even. We are not talking about making profits here, just break-even.

Hence, to protect the capital, always cut your losses at 8% from your purchase price. The rationale for the rule of 8% is that a stock that is expected to perform well rarely falls below 8% of its purchase price, but if it does, it indicates that you’ve made a mistake in your selection and it’s beneficial if you exit.

Lock in Profits:

If a stock is losing high volumes, it usually indicates that an institution is selling it. It is generally a better decision to avoid such stocks and exit the position locking in your profits or cutting down your losses.

It is also advisable that you sell a stock when it rises 20-25% of its purchase price. This’ll protect you from any further volatility having you maximize your profits. An exception to this could be if a stock rallies 20% or more in the first 3 weeks; this shows extra potential and should be held for at least 8 weeks.

General Market Distribution:

One needs to watch out for distribution day in key indexes, the current position in the market cycle, and if the general market direction is down. A distribution day is one when a major index like Nifty50 falls 0.2% or more on higher than previous sessions. Accumulation of distribution days signals the weakness in a market.

For more stock market tips and learning how to invest in stock markets, visit www.marketsmithindia.com.

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