Your stock is losing value. You want to sell, but you can’t bear to think of selling now before further losses or later when losses may or may not be larger. All you know is that you want to offload your holdings and preserve your capital and to reinvest the money in a more profitable security. In a perfect world, you’d always achieve this aim and sell at the right time. Unfortunately, it isn’t that easy in real life. Let’s take a look at why selling is important and then talk about a selling strategy that works for any type of investor.

The Breakeven Fallacy

An Adaptable Selling Strategy

The classic axiom of investing in stocks is to look for quality companies at the right price. Following this principle makes it easy to understand why there are no simple rules for selling and buying — it rarely comes down to something as easy as a change in price. Investors must also consider the characteristics of the company itself. There are also many different types of investors, such as value or growth on the fundamental analysis side.

A selling strategy that’s successful for one person might not work for somebody else. Think about a short-term trader who sets a stop-loss order for a decline of 3%; this is a good strategy to reduce any big losses. The stop-loss strategy can be used by longer-term traders also, such as investors with a three- to five-year investment time frame. However, the percentage decline would be much higher, such as 15%, than that used by short-term traders. On the other hand, this stop-loss strategy becomes less and less useful as the investment time frame is extended.

If you’re thinking about selling, ask yourself these questions:

1. Why did you buy the stock?

2. What changed?

3. Does that change affect your reasons for investing in the company?

This approach requires you to know something about your investing style. If you bought a stock because your uncle Bob said it would soar, you’ll have trouble making the best decision for you. If, however, you’ve put some thought into your investment, this framework will help. The first question will be an easy one. Did you buy a company because it had a solid balance sheet. Were they developing a new technology that would one day take the market by storm? Whatever the reason was, it leads to the second question. Has the reason you bought the company changed? If a stock has gone down in price, there is usually a reason for it. Does the quality you originally liked in the company still exist, or has the company changed? It is important to not limit your research to only the original purchase reasons. Review all of the latest headlines related to that firm as well as its Securities & Exchange Commission filings for any events which could potentially diminish the reasons behind the investment. If after some research you see the same qualities as before, keep the stock.

If you have determined that there has been a change, then proceed to the third question: is the change material enough that you would not buy the company again? For example, does it alter the company’s business model? If so, it is better for you to offload the position in the company, as its business plan has greatly diverged from the reasons behind your original investment. Remember not to get emotionally attached to companies, and making smart sell positions will become easier and easier.

A Value Investor’s Approach

Let’s demonstrate how a value investor would use this approach. Simply put, value investing is buying high-quality companies at a discount. The strategy requires extensive research into a company’s fundamentals. (For further reading, see the chapter on value investing in our tutorial Guide To Stock-Picking Strategies .)

1. Why did you buy the stock?

Let’s say our value investor only buys companies with a P/E ratio in the bottom 10% of the equity market, with earnings growth of 10% per year.

2. What changed?

Say the stock declines in price by 20%. Most investors would wince at seeing this much of their hard-earned dough evaporate into thin air. The value investor, however, doesn’t sell simply because of a drop in price, but because of a fundamental change in the characteristics that made the stock attractive. The value investor knows that it takes research to determine if a low P/E and high earnings still exist.

3. Does that change affect your reasons for investing in the company?

After investigating how/if the company has changed, our value investor will find that the company is experiencing one of two possible situations: it either still has a low P/E and high earnings growth, or it no longer meets these criteria. If the company still meets the value investing criteria, the investor will hang on. In fact, s/he might actually purchase more stock because it is selling at such a discount.

With any other situation, such as high P/E and low earnings growth, the investor is likely to sell the stock, hopefully minimizing losses.

The point here is to think critically about selling. Know what your investing style is and then use that strategy to stay disciplined, keeping your emotions out of the market.