The Common Sense Investor

Long-term investing almost eliminates the need to time the market. But there are still some insights we’d like to share to get the most out of your investment.

If anyone ever comes up with the perfect time to buy and sell stocks, that person will own the world. Right now, timing-based stock trading is based on premises only slighly better than magic. There are, however, some good rules of thumb that you can follow which will help you find the best times to sell your stocks high, and when to cut them loose when they start to drop.

The very most important thing in investing, no matter what your goals, is to know the true worth of the company you’re invested with, and to keep track of that worth. You should only buy a stock when it falls below the company’s true value, and then sell it when it seems overinflated compared to that value. Ignore the “hot stock tips.” It’s not that hard to create buzz, and you have to question why anyone would give you genuine “hot†tips if they didn’t have something to gain from it. Your broker isn’t supposed to tell you anything he wouldn’t tell his other investors, and anyone else with a real tip would be cashing in on it himself, wouldn’t he? Assume that altruism does not exist on Wall Street, and you’ve probably got it just about right.

To find those times to buy, look for situations where a company’s stock price is artificially low compared to its value. But the best time to sell is when you think a stock is overpriced and will not quickly grow into its overvalued price. Watch your stocks as they rise and compare the market value to what you think the real value is. One of the rules of the stock market is that whatever rises, tends to continue rising past where you think it should stop (its called “everyone jumping on the bandwagon”). When a stock hits a point where you are sure that it is significantly overvalued, sell. And then don’t look back. Be confident that you did the right thing, even if the stock continues to climb for a while. No matter how much you may love that stock, it can’t continue to rise past its real value forever.

There are also times where selling when your stock is dropping is a good idea. For starters, dropping stock is likely to keep sinking (again, because investors tend to jump on bandwagons), especially if trading volume is heavy. A good rule of thumb is to sell an unstable stock when it loses 7-8% of its value, unless you have incredibly good reason to think that the stock’s real value isn’t being reflected properly. If you let it drop more, you’re likely to take a real beating, and it’s very hard to make up that loss later. But again, to make a final evaluation, you need to know what you consider the real value to be of the stock. Hopefully you won’t have to wait until a stock loses 7-8% of its value. If you ever have reason to think that the company you are invested in is losing market share or has bad management that’s going in the wrong direction, sell your stock and then get back in bed with a different company with stronger potential.

The best way to get good at knowing when to sell is to practice. Without investing money, start tracking stocks you think will do well. Find out what you can about the real value of a company, and track its stock for a few months to see if your predictions are right, and if you can determine the true value. The better your predictions, the closer to correct your assessment is. When you start to feel confident, that’s when to start buying low and selling high.

At The Common Sense Investor, we think that the best approach is to go long term with excellent companies and to sell the stock only when you think the company is priced way too high (a P/E over 25) or when you think the company has taken a turn for the worse. Otherwise, stick with the companies that are making you money the old-fashioned way, by doing good business.