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Get Smart About Selling Your Stocks

If you want to be a successful investor, it's not enough just to make smart stock picks. You also need to figure out when the right time to sell those picks is. If you don't force your investments to justify their place in your portfolio every day, then you run the risk of losing every penny of the hard-earned profits that smart pick made for you.

Learning the hard way
No matter how much you love a stock, there are times when you can save a lot of money by letting it go. For instance, all five of the following companies share something in common:

Company

Gain

Loss

YRC Worldwide (Nasdaq: YRCW  )

295% (March 2001 to March 2005)

(99.7%) (March 2005 to June 2010)

Ford Motor (NYSE: F  )

117% (March 2003 to June 2004)

(87%) (June 2004 to January 2009)

Sirius XM Radio (Nasdaq: SIRI  )

208% (Aug. 2004 to Nov. 2005)

(98%) (November 2005 to December 2008)

Mosaic (NYSE: MOS  )

626% (January 2007 to June 2008)

(79%) (June 2008 to November 2008)

Southern Copper (NYSE: SCCO  )

709% (June 2005 to October 2007)

(68%) (October 2007 to February 2009)

Source: Yahoo! Finance.

With each of them, you could have made a boatload of money if you'd bought it at the right time. And with each of them, if you didn't see the warning signs ahead of time, you would have lost most or all of the gains that took years to earn.

In particular, bankruptcy threats hit Ford and Sirius during the financial crisis to stop their recoveries in their tracks at least temporarily, and similar problems still plague YRC Worldwide and the outcome remains uncertain. The boom in commodities helped fertilizer maker Mosaic and the Latin America-focused copper company Southern Copper reach big peaks, until the bottom fell out of the commodity markets.

More than just timing
I'll admit that it's easy to throw out these examples in hindsight as stocks you should have avoided once they started going down. But if perfect timing is impossible, then how can you expect to milk every penny of potential profit while getting out at the right minute to avoid losing it?

The answer is that you won't always sell at exactly the right time. But as long as you sell in time to save yourself from potential disaster, then the fact that you leave some money on the table is inconsequential. Here are some things to look out for:

  • Shareholders vs. management. When C-level executives seem to be more concerned about golden parachutes and stock option paydays than investors, you need to look for the exits. Sometimes you'll miss out on gains even in spite of executive siphoning of profits, but often you'll get out at what turns out to be the perfect time.
  • A disappearing moat. Competitive advantages aren't always permanent. If a company can't defend its territory, the loss of its competitive edge can be devastating to share values.
  • Cyclical stocks. It's particularly important to understand when a high-flyer is simply at the top of its ordinary business cycle. For instance, right now Annaly Capital Management (NYSE: NLY  ) and MFA Financial (NYSE: MFA  ) are benefiting from low interest rates and relatively high rate spreads. What investors have to look at is what will happen if those conditions change, as they eventually will. If a stock is truly cyclical, then selling at highs with the expectation of picking up shares much cheaper down the road can be the right move.

In addition, you should look to see if the reasons you bought the stock in the first place are still valid. Even if a company has enjoyed big growth, it may have done so for the wrong reasons, in your view. If you can identify unsustainable trends, you'll escape before the rest of the market figures out the disparity.

Stay aware
You won't always time your exit from a troublesome stock perfectly. More important than your actual timing, however, is the fact that you need to go through the thought process of considering selling your investments -- and it should be a regular part of your overall investing strategy. You should never give an investment a free pass, especially if it has created losses for you recently. If you stay vigilant, you'll sometimes succeed in jettisoning a time bomb in your portfolio before it goes off and causes real damage.

Selling stocks should probably be the last thing on your mind right now. Morgan Housel explains why history says now's a great time to buy stocks.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger often tries to get out while the getting's good. He doesn't own the stocks mentioned in this article. Ford Motor is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy has perfect timing.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 13, 2010, at 2:12 PM, tafter wrote:

    Timing "the market" is difficult, but not impossible. Being educated, continuing to read, and discipline are the keys. Feel free to check out my videos on youtube.com

    tafter12 <-- screen name

    timing the market <-- titles of my videos

  • Report this Comment On September 13, 2010, at 8:21 PM, KZMike wrote:

    tafter. . . you really don't need to yell in your videos. Makes it really tough when the 'vu' meter is bouncing all over the place. . . just settle down an put your info out to us. Yelling, screaming, etc only takes away from what you are trying to say. . . Very interesting 'graph' to say the least however.

  • Report this Comment On September 13, 2010, at 8:54 PM, KZMike wrote:

    tafter12. . . good info in your videos. It would really make it easier on a lot of us, if there was a bit less yelling and screaming. Don't think you need to 'sell' your point with such big swings on the 'vu' meters.

  • Report this Comment On September 14, 2010, at 7:32 AM, FiveHappyDaze wrote:

    To help you recognize market cycles, you should have a good grasp on technical analysis. Stock market timing is a very important aspect when you are trading stocks. Stock market bubbles have led to market crashes numerous times in history, and learning to watch for the common signs leading up to the event is crucial. There are phases that a market goes through, and learning at what phase it is in will help you form a strategy to give you the best return from your stock picks. There are four phases that a market will go through.

    Markets behave in a cyclical manner, they increase, peak, decline, and then bottom out. Once a cycle is complete, another cycle begins. The trick to staying ahead is to know in which phase of the cycle you are. Many investors fail to recognize these phases and forget that the market's increase will at some point come to an end. There is no way to exactly pinpoint where the market phase will change. But by looking for certain signals, we can get a general prediction or where it might occur. This knowledge of stock market timing will help you avoid losing money.

    The accumulation phase is where the market sentiment is still relatively bearish but has bottomed out. Many stocks have excellent value and are attractive to buy; this is good time to start stock picking. The mood turns from negative to neutral.

    The next cycle is the mark up phase, and sees the market relatively stable and it is slowly increasing. As time continues, sentiment is starting to be positive and the bulls are cautiously stepping in. More investors start getting into the market, prices rise further and the sentiment is now very positive. Those who had invested at the accumulation stage now start selling to profit, causing the increases to start leveling off. Meanwhile those who were at the side lines see the market as being stable and start jumping in causing another increase. This situation in stock market timing sees the biggest gains in a short time, a sign the phase is coming to an end.

    The distribution phase sees sellers start to dominate. This causes mixed sentiment. This can cause the market to stay locked in this position for many months. However, the distribution phase can come and go quickly. Investors at this time may be gripped by periods of fear as the markets decline and then start to rise as sentiment improves. This is a very confusing time for investors who are not sure which way the markets are moving.

    The mark down phase is where the market is in decline, with investors who stayed on watching their stock picks going down in value. This phase will continue until the market starts to bottom out again, ending this cycle. Stock market timing is extremely important and investors should be aware of the risks if they get in at the wrong time.

    ----------------------------------

    Money without intelligence is like a car without a road.

    http://www.intelligentinvestingtips.com

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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