3

I have a few assumptions to pre-face this question.

Let's assume you bought a stock thinking that it was going to grow, but it did not.
The best practice that I have seen is that people sell when stocks are going down to avoid further losses. Let's assume that the loss will be more than I want and that I don't need the money now. Should I keep the stock in the hopes that it will go up at some point in the future, or should I sell now and realize the loss and get tax benefit?

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    do you expect it to go up? Would you buy at the current price, if you didn't own it already? – littleadv Nov 11 '11 at 19:29
  • @littleadv - +1 this is a pretty complete answer as far as I'm concerned. – JTP - Apologise to Monica Nov 11 '11 at 19:37
  • @littleadv Yes. I will buy at the current price, but I won't since I am not sure where the company is going. – Geo Nov 11 '11 at 19:53
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    @Geo "Yes...but I won't"--then the answer is not "yes', but "no". But that fact is, nobody ever knows where a company is going, stock-price-wise. You take the best guess you can. – Chelonian Nov 14 '11 at 17:43
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    @Geo... "but I won't since I am not sure where the company is going." - You shouldn't be invested in companies where you don't have an idea of where their business is headed and whether they will grow. If you don't have the time/expertise to analyze a business and their place in the industry, you should let somebody who does handle your investments (e.g. a mutual fund) or take Buffett's advice and buy index funds. – Mike Piche Nov 14 '11 at 23:43
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In my opinion, the average investor should not be buying individual stocks. One reason why is that the average investor is not capable of reading financial statements and evaluating whether a stock is overpriced or underpriced. As such, they're often tempted to make buy/sell decisions based solely on the current value of a stock as compared to the price at which they bought it. The real reasons to buy (or sell) a stock is the expectation of future growth of the company (or continued profit and expected dividends). If you aren't able to analyze a company's financial statements and business plan, then you really aren't in a position to evaluate that company's stock price. So instead of asking whether to sell based on a recent drop in stock price, you should be investigating why the stock price is falling, and deciding whether those reasons indicate a trend that you expect to continue.

If you buy and sell stocks based solely on recent trends in the stock price, you probably will end up buying stocks that have recently risen and selling stocks that have recently fallen. In that case, you are buying high and selling low, which is a recipe for poor financial outcomes.

  • While I agree those are good things to avoid doing that does not mean that the average investor should never buy stocks. There are some specific average investors I would agree with but some are capable of making intelligent investment decisions. – user4127 Nov 15 '11 at 15:53
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    +1 If you don't know enough to determine the company's value, you are just playing casino without the fun. – Eric Nov 15 '11 at 17:33
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    @Chad - Making intelligent investment decisions is different than intelligently picking individual stocks. You have to be either really smart, well informed, or naive to think that you can pick a stock that will outperform the market. By "average investor", I am referring to people like myself who are saving/investing for retirement, but aren't financial advisors or mutual fund managers. I don't have the time or expertise to analyze hundreds of financial statements of companies to find a few that seem to be undervalued and likely to do really well in the future. – Mike Piche Nov 16 '11 at 17:22
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    I really like this answer. Buying a stock is just like buying a business, only one-millionth so. Would you buy a business without understanding the financials? – jprete Nov 16 '11 at 21:54
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The price at which a stock was purchased is a sunk cost--that is, you cannot go back in time and reverse the decision you made to purchase that stock. Another example of a sunk cost would be purchasing a non-refundable, non-transferable movie ticket. Sunk costs have the tendency to create a cognitive bias in which we feel that the amount we paid at some point in the past should have some sort of bearing on the decision we make now--the purchaser of the ticket feels he must go see the movie even if he no longer wishes too, lest the ticket "go to waste"... the investor hopelessly clings to a battered stock for that tiny chance that just maybe some day it will return to its former glory. This is referred to as the "sunk cost fallacy" and is considered to be irrational behavior by economists.

Keeping this in mind, your hopes and dreams for the stock at the time you purchased it should have no bearing on the decision you make now. Similarly, whether the stock has risen or fallen in price since your purchase date should have no bearing. Instead, you must consider what you expect the stock to do from this very moment on into the future--that is, you must act at the margin.

You've indicated that you are faced with two choices--sell the stock now, incur the loss, but benefit from the tax break (Option A). This benefit is quite easily quantifiable--it is your marginal tax rate multiplied by the additive inverse of the loss (assuming you have/will have other gains to offset). Let's just assume that you incurred a $1000 loss, at a marginal tax rate of 20%, which means your tax benefit for the loss is $200.

The second choice--to hold the stock in hopes of it rising in price (Option B)--is a bit harder to quantify. You must assume that today is day zero, and that every cent in price the stock rises is a gain to you, and every cent in price the stock looses is a loss to you. If you believe that the stock will rise to a price that will net your more than your tax benefit from option A, then holding the stock is more favorable than selling it at a loss today. Conversely, if you believe this stock will fall even further in the future, or not rise enough to net you $200 (per the example), then Option A is preferable.

Granted, there are some additional complications that play into your decision. By selling the stock today, you not only get a tax benefit from the loss, but you've also freed up the funds previously used to purchase that stock to be invested elsewhere (in hopefully a better performing asset). If you choose to stick with your current stock, then the gains you may have netted elsewhere must be considered as an opportunity cost associated with Option B. Finally, the tax benefit is essentially guaranteed (so in our example, a $200 risk free return), while sticking with the stock in Option B still comes with some risk.

  • Great answer that details the gain from the tax benefit vs the potential gain of the price increasing. – John Bensin Apr 6 '13 at 21:41
2

Personally, I have been in that situation too often that now I am selling at the first tick down! (not exactly but you get the idea..) I have learned over the years to not fall in love with any stock, and this is a very hard thing to do.

Limit your losses and take profit when you are satisfied with them. Nothing prevents you from buying back in this stock but why buying when it is going down?

Just my 2 cents.

1

The stock price is not only based on the general market trend and the stock's current profitability and prospects, but is also based on prediction of how the stock's prospects might change in the future.

In almost every case, there are professional investors analysing the stock's future prospects and considering whether it's over or under values for its current price. However even professionals can be totally wrong.

If you feel like you have a good grasp on whether the stock will have improving or declining prospects over time, then you might be (if you're right) equipped to make a sensible decision on whether to hold the stock or not. If you don't think you have a good understanding about the stock, then an understanding of the general market direction might at least make stock in general worth holding. Otherwise, you are simply taking a punt.

If you know of another stock that has better prospects, then ask yourself why you would hold onto the stock that you think will perform worse.

But also bear in mind that (in my understanding) research has shown that, on average, people who try to pick stocks rarely do better than a random selection, and more stock trades means more brokerage (which thanks to brokerage losses would mean you will end up doing worse than average unless you really do know better than the market).

0

The standard answer on any long term stock is hold on during the rough times. You have not lost anything until you sell. If your concern is just that you are not certain where the stock price is headed, unless you need the money now and can not afford to hold on to the stock then I would hold it.

0

You should distinguish between the price and the value of a company: "Price is what you pay, value is what you get".

Price is the share price you pay for one share of the company.

Value is what a company is worth (based on fundamental analysis, one of the principles of value investing).

  • If value < price, sell the stock.
  • If value > price, buy the stock.

I would recommend selling the stock only if the company's value has deteriorated due to fundamental changes (e.g. better products from competitors, declining market) and its value is lower than the current share price.

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If the stock starts to go down DO NOT SELL!!

My reasoning for this is because, when you talk about the stock market, you haven't actually lost any money until you sell the stock. So if you sell it lower than you bought it, you loose money. BUT if you wait for the stock to go back up again, you will have made money.

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