Here’s 5 Smart Rules to Know Exactly When to Sell a Stock

Knowing exactly when to sell your dividend stocks is important. And it's one of the many lessons, which pulled me out of danger

I know, it’s hard. And I can tell you for a fact, most people don’t know when to sell their stocks. Sometimes, they’ll exactly sell it at the wrong time. And, out of the many lessons learnt, I think the one which frequently pulled me out of danger is knowing when to sell a stock. 

You see, buying stocks is easy. And there’s so much advice out there telling you when buy. But that’s only half of the investing coin. The hard part, in my opinion is knowing exactly when to sell.

It happens all the time. Imagine, if one of your stocks is down more than 25% from your original buy price.

And the next instance, your invisible voice creeps into your head: “Should I cut my losses now?” or “Should I buy more on the dip?” This is common. And it puts you in a spot. The fight between you and your invisible voice leads you to a state of inactivity. 

Sometimes, you’ll continue to hear this voice while the stock you hold keeps falling. Until it becomes too late to sell. 

I know that feeling. I’ve been there too — Struggling with my invisible voice, whether to cut my losses short. It’s an emotional wreck — the fear, the anxiety, the uncertainty and anger. That you’re afraid you may sabotage your portfolio if you made the wrong choice. It’s perfectly normal.

Here’s the thing. What’s really going on is this — Many people easily fall into this deadly trap called a “loss aversion” bias. It trips even the smartest investors. And it’s a well-known psychological concept on human bias. 

So what’s “loss aversion” bias? It simply means people prefer to avoid losses way, way more than they like winning. It’s like losing $50 in a casino game feels much worse than making $50 from it. This is because when you make losses, your brain releases chemicals which triggers a “fight or flight” instinct. It wants to keep you from losing more. You feel queasy in your tummy, or your pupils dilate and you want to quickly find a place to hide. You emotions turn in to fear, anxiety and anger. It’s inevitable. Fear is the biggest emotional impetus in the stock market at all times. And no matter what, you’ll freeze into inactivity. That’s why people are scared to know when to sell their losers. 

Of course, you can always tell yourself to control your emotions, your fear and anxiety. But the fact is, it’s not easy to simply talk yourself out of it: “No, I’m not scared.”

That’s why you need to have these 5 simple, smart rules to help yo manage these fears. If you follow them to selling a stock, you’ll overcome your state of inactivity. You’ll feel much more at ease. But more importantly, you don’t have to worry about losing sleep over it at night.

Unlike most people out there, you’ll have a solid exit plan of knowing when to cut your losses, and take your profits too.

Here’s when you know exactly when to sell a stock.


Smart Rule #1: When the Long-Term Business Outlook Has Changed

Between you and me, you’ve to treat investing as a business. The moment you decide to manage your own wealth, you’re in business. And in business, when one of your investments is not doing well, you’ve got to cut it loose. Simple as that.

Same for stocks. You see, you want to invest in companies with a durable competitive advantage

But when the company is struggling, it’s time to sell the stock. Struggling could mean the company’s products or services no longer as a competitive advantage. You’ll notice a trend of falling sales, poor earnings, and shrinking free cash flow. Sometimes, the company may pile on more debt to survive. You want to know how to interpret these numbers, so you know when to get out of the stock. . 

Here’s one important thing you need to know. Sometimes, a company may have a sudden drop in sales, or earnings. Don’t be alarmed. You probably wouldn’t want to sell your stock because of this.

I’ll explain.

In 2017, Johnson & Johnson’s earnings dropped 92% to $1.3 billion, down from $16.5 billion in 2016. It wasn’t because business deteriorated. But it had to pay a huge $13.6 billion tax on its accumulated overseas earnings. It was somehow “forced” to bring back its cash to the US, and thus got taxed. This is probably a “one-time” event. And for the record, it’s dividend payment wasn’t affected. And its sales and earnings continued to grow after that. 

Now when a business is struggling, it’s obvious. One example is General Electric. The business took on risky ventures in early 2000 by borrowing a lot of debt. Management thinks the company could do well with a series of acquisitions. 

But when the global financial crisis hit, it almost went into trouble. Until today, General Electric Capital, the financing arm of the company, is still struggling to restructure and sell off its bad assets. 

Valuable assets like its Biopharma and Baker-Hughes were sold to improve the General Electric’s financial health. But General Electric’s sales, earnings and free cash flow continued dropping year after year. It was hard for the company to get rid of its debt. 

Again, learning how to read the numbers is important here. You can read from the numbers, that General Electric’s competitive advantage wasn’t as durable. There’s a change in its long-term business outlook.

So, know your business, and know them well. So, when the long-term outlook of the business changes, you’ll know when you should sell your stocks.


Smart Rule #2: When Dividend Payment is At Risk

Rising dividends is the hallmark of financial excellence. As conservative dividend investors, you’ll know that a large part of building your wealth comes from dividend income.

You see, dividends help fund your retirement and meet income needs. And the last thing you want tis have your dividends getting cut.

Here’s something to remember. How much dividends is paid, determine the value of your stock. In Chapter 5 of The Theory of Investment Value, by John Burr Williams, He defines: “The investment value of a stock as the present worth of all the (future) dividends to be paid upon.”

If your dividends are at risk, the value of your stock will go down.

A few ways is to look at this is to check a company’s dividend payout ratio, its dividends paid, debt levels and earnings growth. If the company is lowering its dividends per share year after year, it could be a tell-tale sign that the business’s dividends are at risk.


Smart Rule #3: A Better Dividend Stock Idea Comes Along

What truly matters to growing your wealth in retirement is to accumulate a basket of solid, dividend growers

And you want to find the best dividend stocks to do that. But don’t forget, when you own a diversified portfolio, you’ve only so many stocks you can responsibly own. You can’t always be adding new stocks, otherwise you’ll end up with a few hundred of them. It’s hard to manage.

Simply put, you’ve to think about opportunity cost here. What do I mean? 

When you’ve found a way better dividend stock — Potentially a better business, grows its dividends faster, company has higher sales growth, stronger earnings power. And more importantly, it’s trading at an attractive price.

At this point, don’t be afraid to switch out your existing stock for a better one. It makes more sense if you want to grow your wealth faster.

Here’s an example. Say you own Stock A which pays you a dividend yield of 4% per year. But its dividends don’t increase at all. Then, you found Stock B, which also pays 4% per year, but it has a very strong trend of raising dividends year after year. Now, this new stock also has a higher sales and earnings growth. And its future potential is much higher than Stock A. 

Then it may make sense to buy into Stock B and sell Stock A.

For me, a starting point is to compare stocks in the same industry. It’s easier to assess the trade-off between two stocks. And allows you to better make decision on when to sell your dividend stocks.


Smart Rule #4: When You’ve An Unusually Large Position Size

You know, this is a good problem to have. I’m not saying to take profits here. It’s entirely different. When one of your stock positions get too large, start trimming. Because:

  1. You don’t want to risk a very huge exposure to one stock.

  2. You want to maintain diversification benefits.

For example. One of your stocks doubled to more than 9% of your portfolio. Now, what you want to do is to start selling some of it to get it back to below 5% of your portfolio. I think it’s a comfortable “position size” for one stock. Even if the company has a very high quality business. 

As far as I’m concerned, as a conservative, dividend investor, you want to reduce as much risk for yourself as possible. Your portfolio will be more stable, less “bouncy” to the up and downs of the market.

You want to review this regularly, to make sure your stock positions don’t get too large. 

This way, you’ll still harness the proven benefits of diversification, while creating massive gains for your income-producing portfolio.

Here’s the thing, different portfolios handle different levels of risk. A large and well-diversified portfolio can quickly rebound from a loss due to one bad stock. But a smaller, more concentrated portfolio could be sabotaged by one big risk.

And what you want is to reduce the chance of having that big risk affecting your portfolio. Its safer this way, and puts you at ease.

So, when you’ve an unusually large position size, it’s time to sell some of the stock.


Smart Rule #5: Use a “Cut-Loss” Strategy

Sometimes, when it comes to stock investing, you must have a “hard trigger” to let your winners ride. Its a lot like taking out the weed. If you keep this rule with you, you’ll have the best chance of not only outperforming the market, but you’ll get better at growing your wealth in your retirement.

Sometimes none of the other 4 rules apply, yet your stock is falling like no tomorrow. You’ve no idea what’s going on. Then you might want to use this.

It’s last-resort measure to make sure your portfolio does not get wrecked. And it works.

It’s called the “30% Cut-Loss” rule. Its a “hard trigger” where you sell your stock positions at 30% off their highs. If you bought the stock at $50 and it drops to $35, sell no matter what happens. Or if you’ve bought a stock at $10 and it goes up to $20, when should you sell it? Sell it at $14, no matter what happens. 

Because, sometimes the stock drops for no reason, it could be an insider information you might not know yet, or the risk is much deeper than it sounds. And you might be missing out on critical information. So to prevent your portfolio from getting sabotaged, sell it if the stock drops by more than 30%.

Why 30%? Frankly, there’s no magic formula behind it. What’s more important here is the discipline. 

You see, many fund managers use this strategy when they manage multi-billion dollar funds. They simply cannot afford to make unnecessary losses for their clients, especially if the amount is so big. 

Ultimately, you never want to be in the position where your stock has fallen by more than 50%. Because the stock has to rise by 100% for you to breakeven on your investment.

Think about it this way. If a stock drops from $50 to $25, you need to wait for the stock to double from $25 to $50.

So, by simply using this last-resort measure, you save all the trouble of being in this situation.



So there you have it.

The 5 smart rules to know exactly when to sell a stock. 

But what if the stock reaches a target price or if the stock is overvalued? Do I still sell it? For me, I think the best way for dividend investors is to hold stocks for the long term. Ultimately, you’re looking for companies which have huge growth potential and able to keep growing its business. If the company is growing, and paying ever rising dividends, why is there a need to sell the stock? 

And don’t forget this. When you sell a stock, you need to find another stock to replace. This is to maintain diversification benefits for your portfolio. Finding a replacement stock means you need to spend time looking for stocks again. This takes time. And you want to reduce as much unnecessary work as possible.

Once you’re able to sink these rules into your investment framework, it’s going to pull you out of any trouble easily. 

You’re better off taking small losses than big losses

It’s better to let your winners run than taking profits on them prematurely.

By following these few smart rules, you’ll be well on your way to successfully growing your wealth safely, consistently and profitably.

That’s it for now.

Always here for you,

Willie Keng

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2 years ago

Thank you for your insights. Calm and rational. And always useful.

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