Buy. Sell. Hold. Buying and selling stocks can sound exciting, complicated, and confusing all at once. But it doesn’t have to be. The first step to understanding when to buy and sell stocks is knowing how a stock market or stock exchange works.
The first thing to know: There isn’t just one stock market—there are many stock exchanges and markets worldwide through which people buy and sell stocks, or shares of a company.
Stock markets or exchanges consist of lots of people buying and selling at different prices because they all have different ideas about those stocks’ value. One investor might think a stock will go up, while another thinks it’s going to go down. So who’s right about when to buy stocks?
Understanding When to Buy and Sell Stocks
The fundamentals of when to buy a stock and sell a stock comes down to the basics of how a stock market works. The idea is to buy low and sell high: If you buy a stock for $1 and sell it for $2, then you’ve made a profit.
In the short term, any given stock could go up or down on any given day, for a variety of reasons. Perhaps the fundamental business behind the stock is bad and the company is going to lose money. Or the stock price could change because of a report from an analyst, a rumor about coming business actions, or overall economic news.
Because of all that volatility, it can be risky for individual investors to buy and sell stocks to make a profit, so many investors prefer investments like ETFs, index funds, or mutual funds, which contain many stocks in one neat package.
Keep in mind, past performance is no guarantee of future results. For example, in 2018 the S&P 500 saw a -6.24% return, whereas in 2019 it saw a 28.88% return.
It can be hard to know when to buy and sell stocks, even for professionals. Money managers try to beat the market by actively buying and selling stocks instead of investing in funds—but in fact, in 2019, only 29% of U.S. stock fund managers beat their benchmark.
Even if a passively managed index fund might be a better long-term investment, there are still lots of reasons people want to trade stocks: because they enjoy it, because they want to take a more active role in their financial goals, because they want to make specific choices with their investments (like investing in socially conscious businesses or in businesses they support).
For individuals looking to start investing, there are certain concepts to know: diversify, start small, focus on overall investing, and have long-term goals. Most important, one needs to know when to buy and sell.
How Do You Know When to Buy a Stock
When an investor has done their research and feels confident that a stock price will rise in the short or long term, and that they’re willing to hold onto it until it does, that’s the right time to buy a stock.
It helps to be informed when considering whether to buy stocks, and one way to do that is to learn about the company itself. Interested investors can find many company’s financial reports and earnings reports from the SEC in their EDGAR database .
While ultimately it can be a good idea to buy stocks across different industries in order to diversify, it sometimes helps to start with a business or industry one is familiar with. Knowing about the company can help put the earnings reports into context.
Understanding the value of stocks is always tied to understanding the business those stocks represent a share in. Is the company a good investment? Does it have sound financials and growth potential? Here are helpful questions to consider when contemplating buying a stock:
What is the price range at which you’re willing to buy? If an investor has a company in mind, setting a price range at which they would want to buy stock in that company may help inform their decision. One can do this through analysts’ reports and consensus price targets, which average all analyst opinions.
Does the stock appear undervalued? There are different ways to determine value. The most common valuation metric is a price-earnings ratio (or P/E), which takes the price per share and divides it by earnings per share. The lower the number, the less the value. Generally for U.S. companies, a P/E below 15 is considered a good value and a P/E over 20 is considered a bad value. You can also compare the company’s P/E to others in the industry.
Another way to look at value is a discounted cash flow (DCF) analysis, which takes projected cash values and discounts them back to the present. This ultimately gives an investor a theoretical price target; if the actual price is below the target, then in theory it’s undervalued and a good buy.
Does the stock offer dividends? A stock that distributes profits in the form of dividends to shareholders isn’t necessarily a better investment, but dividends have played a notable role in investor returns during the past 50 years. This goes back to 1978, where 78% of the total S&P 500 Index returns were attributed to dividend reinvestment and compounding interest.
The key is to stay informed and make investing decisions based on sound research. It can be tempting to follow the trendy stock, but sometimes it’s more hype than it is worth.
How Do You Know When to Sell a Stock
Just as an investor can set a price range about when they want to buy a stock, they can also set a price range for when they want to sell. It pays to stay on top of the stock value—and when the valuation no longer justifies the price, it may just be time to sell.
In general, if you buy a stock, you’re going to want to hold onto it for a while. When an investor buys an undervalued stock, it could take a few years for it to reach its correct valuation. And of course, there’s always a risk it will never reach what the investor has determined is the correct valuation.
Not everyone holds onto their stocks for a long time, but there are risks to day trading—when people try to make trades up and down every day. Investors who do this often, lose money.
Some investors rely on a rule of thumb that states that the stock market reaches a high point in May or June and then goes down over the summer until September or October. While that can sometimes be observed in overall market behavior—partially because traders (just like lots of people) go on vacation in the summer and partially because it’s a bit of a self-fulfilling prophecy—it doesn’t mean an individual stock will definitely go down over the summer.
Taking this advice—and other folk lore-based advice like this‚ with a grain of salt.
Reasons to Sell Stocks
There are a number of situations in which an investor might decide to sell a stock.
A Loss of Faith in the Company
An investor might have bought a stock with hopes of promising returns, or because the stock was reasonably priced when they bought it. But if it now appears that the tables have turned and the business fundamentals are on the decline, it might be time to consider reinvesting those funds elsewhere.
Some causes for concern might be if the company has an increase in competition, declining profit margins, legal problems, or new questionable leadership. Still, it’s crucial to identify if these changes are short-term and will adjust shortly or if they have long-term consequences that may change the business for good.
Opportunity cost is when the cost of one decision comes at the cost of making another. In other words, when you spend your money on one thing, you cannot spend your money on another.
This concept can be applied to investing in stocks. When you invest in one stock, you may not have the funds to invest in another. Therefore, an investor would want to evaluate every investment decision to determine if their money could potentially be more profitable elsewhere.
The Stock is Overpriced
When comparing stocks, investors often use the price-to-earnings (P/E) ratio to value a stock. The higher the number, the higher the price is in comparison to the earnings of the company.
However, this data alone may not illustrate whether a stock is going to perform in the future. Adding other data points such as historical ratios and earning multiples of competing companies may help investors decide if they are priced reasonably or overpriced. If the stock is overvalued for any reason, it may be time to reconsider the investment.
A Need for Liquidity
There may come a time in an investor’s life when they need to sell a stock for personal reasons, such as to free up cash for an emergency expense. For an investor in this situation, it’s wise to evaluate each stock they own to determine the best stock to sell.
One way to start: Assess which stock has the worst-looking prospect for future growth. Or an investor might decide to sell the stock based that would yield the least tax liability.
To Avoid Capital Gains Tax
While taxes shouldn’t be the sole driver of selling a stock, sometimes they weigh heavily on an investor’s decision to sell. This is because when an investor purchases stocks outside of a retirement account, any gains are subject to capital gains tax.
It’s possible to offset some of the capital gains taxes by buying stocks at a loss. This strategy—known as tax loss harvesting—is sometimes automated, and sometimes not, but if an investor is considering it, they might want to consult with a tax professional before moving forward.
Investors with diversified portfolios may need to sell some stocks from time to time to rebalance their investment mix. Rebalancing your portfolio allows you to review the assets you’ve invested in and confirm that the percentages are still suitable for your goals and objectives. If not, an investor may have to sell some assets while buying others.
How Do You Know When to Hold Stocks
Knowing when to hold a stock often comes down to one’s investment strategy. With a passive investment approach, investors invest in various stocks with the intention of holding them for an indefinite amount of time. This is also known as a buy and hold investment strategy.
With this type of investing, investors attempt to match a market index such as the S&P 500 and the Dow Jones Industrial Average. So, they select stocks in that market index coinciding with the same percentages in that index.
One benefit of the buy & hold strategy is that the tax rate on long-term capital gains (from stocks that an investor has owned for more than one year) are much lower than that of short-term capital gains.
Knowing when to buy, sell, and hold stocks can be less confusing when an investor does the research into company health, overall market conditions, and their own financial needs as relates to personal short-term and long-term goals.
One of the easiest ways to buy and sell stocks or manage any investment portfolio is to open an online taxable brokerage account. This is often appealing to investors who want to take more of an active investing approach and buy and sell stocks. Investors would typically pay fees based on the account and the number of trades they make.
For investors who prefer a more passive approach, there are other options. With an automated investing platform like SoFi Invest®, investors can put their money in ETFs that mimic the financial indexes. Another option is to open a wealth management account and have more guidance in your financial strategy.
For investors who want a mix of hands-on buying and selling of stocks as well as more passive investing, SoFi Invest® offers advantages of both—with human advisors to offer investment guidance and automation to keep the investments balanced.
Choose how you want to invest.
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