There is always risk involved when you invest in stocks. As many investors will tell you, the stock market is where you will be able to earn a lot of money or lose a lot of it in a very short span of time. Even if you have conducted the necessary research and believe that a company has promise, circumstances that are beyond your control can cause a stock to go sour and your investment to lose value.
One of the most disheartening moments in your life as an investor is seeing a stock decline. When that happens, your emotion will tell you to either sell your holdings before the price drop continues further and make your investment lose even more value or hang on to it in the hope that it will eventually make a rebound.
This can be a very confusing time for you so it’s important not to let your emotions override clear and rational thinking. Before selling a loss, you should evaluate it based on certain criteria. Dumping a losing stock is much more difficult than buying a stock for the first time because a lot of factors—including difficulty admitting that you made a wrong investment decision when you bought that stock—come into play. Here are ways to determine if it is the best time to offload a stock you’ve paid far more than they are worth:
For you to be able to answer this question honestly requires that you have given a lot of thought to your investment. That is, before you bought that stock, you should have looked into the company’s fundamentals and determined that based on your investing goals, this stock would make a good fit for your portfolio. There must also be something in that company—the need for their product, the quality or the high demand—that compelled you to become a shareholder.
After you have asked yourself what the reason is, you should check if that reason is still there. For example, if you originally bought the stock because you believed in the caliber of the executives managing it, check if that reason is still there. Perhaps there has been a management shakeup and the people you thought were capable of bringing the firm to greater heights are not anymore there. Or maybe you bought the stock because the company made such a great quality product. Check if that quality still exists.
Check if that change materially affects your investment in the company.
The next step is to decide if what has changed in the company materially affects your investment. Let’s expand the first example further: If the company’s management has changed to such a degree that the new team has altered its business strategy which consequently led to poor performance, it might be practical for you to divest the stock.
However, if the stock has underperformed mainly because the poor economy has led people to spend less then you might want to hold on to the stock unless something else compels you to offload it.
When a stock declines, analysts will have their say about it and make predictions based on the data they have access to (which you will most likely not have). Read newspapers or do a web search and determine what they have to say about the company. If you notice that their opinions about the company are divided, perhaps you might consider waiting it out. However, if they are one in their opinion on how the company will perform, then you can either sell or hold on to the stock if what they say jibes with what you think about the stock’s performance.
In some industries, there will always be great companies, mediocre companies and poor companies. In the airline business, for example, you will notice that more flyers prefer a certain airline because it has been proven to give a safe and excellent flying experience. In the transportation industry, there will always be buses that are trusted because they have low accident records.
If your company is constantly trumped by its rivals, you might consider offloading the stock unless you can see other reasons for not doing so. Before you sell, consider looking at the other areas of the company as well. If you see that it will not be able to step up to the competition no matter what they do, then strongly think about divesting it.
When experts and money managers determine the chances of a stock, they will usually set a condition for it to get back on the road to recovery. An event—perhaps a change in leadership or the opening of a particular branch—is a condition for that stock to recover. Now if that event happens and the stock still continues its downward spiral, perhaps it might be wiser to sell.
Make sure that you take the time element into consideration before divesting a loser. For instance, if the condition you are waiting for is a change in leadership, you can’t expect the company to recover immediately. You have to give it time. Sell only when you have given your stock sufficient time to bounce back after the condition has occurred.
For some investors, pride is the very thing holding them back from selling. They just don’t want to admit that they have picked a highly-speculative and wrong investment from the start. Selling the stock would be tantamount to admitting their mistake. If you are one of these investors, it’s time to get pride out of the way and do the best thing for your portfolio.
Look at the company’s fundamentals, the opinion of analysts and the general condition of the market. If everything else points to the need to sell and only your pride is holding you back, there’s no reason for you to keep that investment.
For some, it’s the emotional attachment to the company that makes them want to hold on to the stock. Perhaps it reminds them of some special time or they have a particular fondness for its products. However, the business environment is fiercely competitive. If the company is not able to compete with the others in the industry, then their stock is certainly going to decline. They might even go belly-up if nothing is done about you, rendering their stock worthless.
If this describes you, do not hesitate to sell your stocks while you can still salvage whatever is left of your investment. You’ve probably heard the saying “it’s a dog eat dog world out there” and that is very true for the business landscape. As an investor, you should not develop emotional attachments to stocks and companies. Heartless as it may seem, you have to be cold and calculating as far as your investments are concerned. If a stock is not performing the way it should, don’t hesitate to dump it.
Dumping a losing investment is never easy. However, you have to do what is best for your portfolio. Selling a loser will clean up your portfolio and enable you to focus on the investments that will actually give you returns. Besides, divesting losers does not mean that you have actually lost your entire investment. You can declare a capital loss when you file your tax return and get the necessary deductions. Any refunds you get can be used to buy other investments.
Remember that the reasons given above are merely guidelines. They don’t fit all investors. You will have to think about and research your investments carefully before deciding to dump your losers. Also, it’s important to have an exit strategy ready beforehand. You will have to form your own set of criteria as to when you should divest losing stocks. For example, someone who trades for the short-term might have a stop-loss order when his stock plunges 3 percent. If you are holding on to your investments for five years, perhaps you might consider a stop-loss strategy if the percentage decline of your investment is at 15 percent or 20 percent.
This is just one type of exit strategy used by investors. Think about your own carefully well before the time comes for you to actually sell your investments. This will greatly reduce the chances that you will continue to hold on to worthless investments for an unnecessarily extended period of time. Never let your emotions take over when deciding to exit your investments.
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