5 Expert Strategies to Know When to Sell Stocks

Investors may find it challenging to decide when to sell a stock. At times, their decisions may be influenced by fear and greed. Successful traders learn to remove the emotion from their decisions so they rely solely on a structured approach. Five common strategies can offer you clarity and discipline when you have to decide to exit a position: valuation-level, opportunity-cost, deteriorating fundamentals, down-from-cost, and the target-price strategies. These methods can ensure your decisions are based on logic and analysis instead of short-term market reactions and impulses.

Selling When Stocks Reach Target Valuations

The first selling category is called the valuation-level sell method. In the valuation-level sell strategy, the investor will sell a stock once it hits a certain valuation target or range. Numerous valuation metrics can be used as the basis, but some common ones are the price-to-earnings (P/E) ratio, price-to-book (P/B), and price-to-sales (P/S). This approach is popular among value investors who buy stocks that are undervalued. These same valuation metrics can be used as signals to sell when stock becomes overvalued.

As an illustration of this method, suppose an investor holds stock in Walmart (WMT) that they bought when the P/E ratio was around 13 times the earnings. The trader looks at the historical valuation of Walmart stock and observes that the five-year average P/E is 15.8. From this, the trader could decide upon a valuation sell target of 15.8 times earnings as a fixed sell signal.

Maximizing Returns With Opportunity-Cost Selling

An additional strategy is called the opportunity-cost sell method. In this method, the investor owns a portfolio of stocks and sells a stock when a better opportunity presents itself. This requires constant monitoring, research, and analysis of both their portfolio and potential new stock additions. Once a better potential investment has been identified, the investor then reduces or eliminates a position in a current holding that isn't expected to do as well as the new stock on a risk-adjusted return basis.

Selling Stocks With Weakening Fundamentals

The deteriorating-fundamental sell method will trigger a stock sale if certain fundamentals in the company's financial statements fall below a certain level. This selling strategy is similar to the opportunity-cost sell in the sense that a stock sold using the previous strategy has likely deteriorated in some way. When basing a sell decision on deteriorating fundamentals, many traders will focus mainly on the balance sheet statement, with an extra emphasis on liquidity and coverage ratios.

For example, suppose an investor owns the stock of a utility company that pays a relatively high, consistent dividend. The investor is holding the stock mainly because of its relative safety and dividend yield. Furthermore, when the investor bought the stock, its debt-to-equity ratio (D/E) was around 1.0, and its current ratio was around 1.4.

In this situation, a trading rule could be established so that the investor would sell the stock if the D/E ratio rose over 1.50, or if the current ratio ever fell below 1.0. If the company's fundamentals deteriorated to those levels–thus threatening the dividend and the safety–this strategy would signal the investor to sell the stock.

Using Price Fluctuations to Guide Stock Sales

The down-from-cost sell strategy is another rule-based method that triggers a sell based on the amount (i.e. percent) that an investor is willing to lose. For example, when an investor purchases a stock, they may decide that if the stock falls 10% from where they bought it, they will sell it.

Similar to the down-from-cost strategy, the up-from-cost strategy will trigger a stock sale if the stock rises a certain percentage. Both the down-from-cost and up-from-cost methods are strategies that will protect the investor's principal by either limiting their loss (stop-loss) or locking in a specific amount of profit (take-profit). The key to this approach is selecting an appropriate percentage that triggers the sell-by taking into account the stock's historical volatility and the amount that an investor is willing to lose.

Selling at Pre-Determined Price Targets

The target-price sell method uses a specific stock value to trigger a sell. This is one of the most widely used ways by which investors sell a stock, as evidenced by the popularity of the stop-loss orders with both traders and investors. Common target prices used by investors are typically based on valuation model outputs such as the discounted cash flow model. Many traders will base target-price sells on arbitrary round numbers or support and resistance levels, but these are less sound than other fundamental-based methods.

The Bottom Line

It takes a lot of discipline to remove the emotion from your investment decisions, especially when you're facing losses. The idea of success doesn't just come from choosing winning stocks, but also from knowing when to sell them. The strategies discussed in this article, ranging from valuation-based to target-price strategies, offer practical tools to make thoughtful, informed selling decisions rather than reacting emotionally to market swings.