Updated on 03.06.07

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

Trent Hamm

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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  1. jake says:

    Another tip that I also like is to set a price that you are committed to selling. Lets say your stock is currently at $15 and through research you know that you should sell at $20-$25, set the price and commit to selling when you’ve reached it.

  2. Good advice all around. My comment was more about the media that says to buy during even times and buy more during quick downturns (picking up bargains on the cheap). The media rarely says to take some chips off the table.

    That said, sell when “the investment no longer makes you feel confident.” is tough specifically because an individual investor feels most confident when the market is at the top.

    As for “It’s much easier to see that you’re getting a good buy when the market goes down” I was in that camp for some time. In 2000, I bought on the initial pullback of tech stocks. With the Nasdaq at 5000+ getting in at 4000 was a 20% discount – great as long as it doesn’t drop to 1200 as it did. Similarly, I bought a good portion of Worldcom (a solid blue chip with real world assets) several times due to it being “a bargain.” We know how that went. In general I like this advice, but it can be hard to decern a whether a free-fall is going to take place after the first 5% loss.

  3. Jamie says:

    Remember what that one kinda smart guy from Omaha said: My favorite holding period is forever.

  4. Margaret says:

    Advice I have read — set prices at which you will sell both BELOW your purchase price (to keep you from holding on to a losing stock) and above. Also, you can always sell SOME of you stocks to lock in a profit. Easy example – if your investment has doubled, sell half – that is, take back your original investment.

  5. Roger says:

    Good advice, Trent. I would argue that there’s a third good reason to sell: to rebalance your portfolio. If you find your assets differ significantly from your ideal asset allocation (and you have no reason to change your asset allocation given your current situation), it might* be worthwhile to sell the outperforming parts of your portfolio and add funds to the laggards. That way, when the market readjusts, you’ll benfit by having bought low and sold high (or in our current market, by selling low but buying even lower).

    *I say might, because there are tax issues (in non-retirement accounts) as well as commission costs (for stocks) that must be considered before selling assets to reallocate. Plus, if you are not that far from your ideal allocation, it may be possible to readjust simply by shifting your contributions.

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