If You Buy When The Market Is Down, When Do You Sell?

Yesterday, I discussed in detail my reasons for making a substantial stock buy even in the face of a 5% market drop in the last week. In response to that, Lazy Man made the following comment:

I think it’s interesting that everyone always says to buy when others are selling, but while the Dow was enjoying new all-time highs for a couple of months, I didn’t hear everyone say “sell because others are buying.” Because you don’t hear that side of things, we are reduced to always buying.

In theory, an individual should sell when the market is at the top, but it’s very difficult for an individual investor to clearly determine when the market is in fact at a top.

So when should an individual investor sell? There are two reasons why an individual investor (who isn’t a professional institutional investor) should sell:

The investment no longer makes you feel confident. If you regularly do homework in the investments you own, you’ll eventually begin to get a gut feeling about the investment. When this feeling is strongly positive, you buy, but when that positive feeling goes away, it’s time to sell.

You need the cash (or something really safe). The only other time to sell is when you need your investment out of the market and in something less volatile. For us younger people, this would be cash; for people nearing retirement, this could be bonds, so you aren’t vulnerable to short-term corrections (like what just happened).

In short, “sell because others are buying” is a great plan, but to actually use it, you have to be able to predict when the market is near the top, which is quite hard. It’s much easier to see that you’re getting a good buy when the market goes down than it is to see when the market is near a top so you can collect profits. The truth is that you should sell when you think the investment is getting weaker, regardless of the general market, and you should also sell when you need the money.

On the other hand, you should not sell just because others are selling. Ignore what the sheep are doing. Look at the numbers and see if anything has really changed. Usually, the fundamentals (P/E, for example) will get better during a selloff, which is why it makes sense to buy something you like anyway during a downturn.

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