Learn when to Sell a Stock in the Markets

Learn when to Sell a Stock in the Markets

The decision to buy a stock has been adequately discussed and debated ad nauseam. But, the bigger challenge is how to sell a stock. Remember, you book profits and realize the profits into your bank account only when the stock is sold. Otherwise, paper profits are of little value unless they are actually realized. That is why selling is so important. There has been a lot of ink spent on how to identify stocks and how to buy stocks as well as why to hold stocks for the long term. However, even the top stock research or the stock market tips that float around, don’t tell you about the right time to sell. Ask any small investor and he can tell you about the best stocks to buy in India. Most people learn how to invest in stocks but not how and when to exit. That is equally, perhaps, more important.

That is why, it is essential that when you learn share market basics from even the most trusted source, insist on knowing how to sell the shares. That will give you a complete perspective. Remember, there can be an array of triggers to sell a stock. There are fundamental triggers and then there are technical triggers. In addition, there are news-based triggers that can induce you to sell a stock or the index. It is essential to understand stock market buy and sell signals. You must know how to buy and sell shares for beginners, not just focus on the first half of the trade. Your reasons can be fundamental, technical, news based or portfolio based. That is fine. The idea is that when the trigger is reached, you exit the stock and book the profits. 

Let us look at 7 such signals that will tell you when to exit a stock in the market. We will start with the portfolio and technical triggers and then move over to the fundamental triggers to sell the stock.

1. When your portfolio sell has been triggered

Typically, your portfolio sell call would be triggered for 2 reasons at an allocation level. Firstly, if you have bought the stock for a goal and the time has come to pay for the goal, it makes sense to exit the stock and first meet your goal. Secondly, you must sell stocks if your portfolio allocation has got skewed. For instance, you start with an equity / debt / liquid allocation of 65:30:5. Due to a rally in the stock markets, your allocation to equity has gone up from 65% to 82%, then it is time to just sell equity and correct the allocation. Then, other factors don’t matter too much.

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Table of Content

  1. 1. When your portfolio sell has been triggered
  2. 2. When technical indicators are strongly negative
  3. 3. If bond yields are spiking it is time to sell
  4. 4. Exit companies where working capital is badly managed
  5. 5. Be wary of high debt and low coverage ratios
  6. 6. Sustained index declines supported by volumes
  7. 7. High P/E ratios and low dividend yields

2. When technical indicators are strongly negative

It is said that technical indicators don’t capture the full story. But often, it has also been noticed that the technical indicators have been good lead indicators of the future of the stock and in most cases, the charts have given signals well in advance. If you find multiple confirmations that the stock is losing momentum, is overbought and most technical indicators are negative, then it is time to quickly ratify with fundamentals and sell the stock. After all, it is better to be safe than sorry.

3. If bond yields are spiking it is time to sell

This is the first major macro trigger that equity investors should watch out for. Firstly, remember that rising bond yields are normally an outcome of rising inflation. We have seen that trend in India since the start of 2022. Higher bond yields mean there will be rising cost of funds and that has negative implications for companies, especially the capital hungry companies. There is another angle to rising bond yields. For example, higher yields on bonds would raise the weighted average cost of capital for Indian companies. That means, future cash flows will be discounted at higher discounts leading to lower valuations. In such cases, it is best to exit the stocks, especially the ones that are more rate sensitive.

4. Exit companies where working capital is badly managed

Most of the companies have their liquidity problems in the way they manage their working capital. Not too many companies are like Amazon having strongly positive working capital, which is what makes Amazon so valuable. There are two kinds of problems here. The first problem is negative working capital when current liabilities are more than current assets. If the current assets cannot meet the current liabilities then the company has to rely on long term assets to meet the current liabilities. That can result in maturity mismatch between assets and liabilities. The second problem is a very high current ratio, a problem that Arvind Mills had in the mid-1990s. Such companies are locking up too much funds in working capital and that is inefficient use of money. These are signals to exit the stock.

5. Be wary of high debt and low coverage ratios

From the days of Polonius, debt has continued to be a bad word and that holds till date for businesses. The first stress signal is when the borrowing cost goes up and shows up in falling interest coverage ratio. You can also assess the debt service coverage ratio rather than just the interest coverage for a clearer picture. Be cautious if both these ratios are consistently falling. If the company has problems like too much debt compared to free cash flows, high cost of funds, trouble in rolling over or rating downgrades, it is time to exit the stock. Rating downgrades may not happen or it may even happen too late. It does not always make sense to wait for the rating company to take action. As an investor, you need to be proactive and exit the stock when you smell the first signs of trouble in the leverage situation.

6. Sustained index declines supported by volumes

This is more of a macro factor. If you look at the market peaks of 2000, 2008, 2010 or even 2020; they were followed by prolonged periods of market correction. A correction of 8-10% is normal but 15-20% correction is a sign of troubled times. Mostly, in such cases, either the valuations are too high or the headwinds are too strong. Either ways, it is time to exit the stock. This is a macro trigger, so you can use it as a trigger for your entire portfolio.

7. High P/E ratios and low dividend yields

High P/E ratio and low dividend yield can be relative. That is why, it is best compared with the historic averages or sectoral benchmarks. An oil marketing company is available at single-digit P/E ratio, a capital goods company may be available at 25 P/E while an FMCG company may be quoting at a P/E of 60. The answer is to either use the peer group benchmark or the overall historical average. Some variation is OK, but PE ratios of over 30 and dividend yields of under 0.50% are classic cases of overpriced markets. This can be an important trigger to sell the stock and exit.

Remember, in the stock markets, profit is what is booked. All else is book profits. That is why it is important to have a clear grasp of when to exit stocks, either individually or in toto.