Anyone who has worked long enough in the stock market would know that the selling decision is far more difficult than the buying decision. Sell too early and investors miss out the bulk of the profits since the latter part of a bull market is very vicious. On the other hand, selling too late can mean watching notional profits becoming a fraction of what they were (and on many occasions of turning into losses) as the market tanks and investors cannot let go of the stocks at a huge discount to the recent peaks.
However, the following are a few ways which can help in making better selling decisions and mitigating these risks to some extent. I use the acronym BEAST to help me remember the selling triggers and also to remind me about the nature of the stock market 😊
1) Bubble in the overall market
In the long run, broad markets give returns in line with the nominal GDP growth. In the Indian context, this can be taken as around 12-13% (6-8% real GDP growth and 4-6% inflation).
While there is no precise definition or indicator of a bubble in the market, very high trailing returns at a broad market level over a long period of time is a decently good indicator. For example, if Nifty has been giving say over 30% returns for the past two-three years or more than 20% returns over say last five years, or say over 18% returns over the last eight to ten years then investors should begin to worry about a bubble.
In such a scenario, staggered selling can be a useful strategy. Investor can start selling in three to four tranches thereby ensuring a win-win whichever direction the market moves in.
2) Euphoria in an individual stock
I define euphoria as a very high trailing return in a particular stock or sector. Suppose there is a stock/sector in the portfolio which has given multi-bagger returns (could be 2x, 3x, 5x, etc) then a reality check has to be done.
One way to do that is to make a rosy scenario about the earnings and PE multiple of the stock for the next year or two to see the maximum return that can be had from the present day onwards. If this CAGR is not satisfactory then part selling is in order. Also, make a base case scenario with reasonable earnings growth and PE multiple. If this gives a steep loss then again part selling is in order.
3) Asset allocation rebalancing
The bulk of the profits in investors’ financial journey come from asset allocation between equity, debt, real estate, gold, etc. Asset allocation differs from investor to investor and has to be carefully decided upon.
Investment in asset classes needs to be rebalanced if allocation skews too much beyond the personal optimum. For example, if the personal optimum Equity:Debt allocation for an investor is 40:60 and it becomes 60:40, then it calls for rebalancing.
Furthermore, rebalancing is also required if an individual stock/sector allocation increases to unreasonable levels. For example, if a stock/sector becomes more than say 25-30% of the portfolio, then pruning can be considered as a risk-mitigating strategy.
4) Something better
This is a no-brainer. If some better investment comes along, then switching from an existing position can be done. Similarly, if some asset class becomes very attractive, say debt becomes more attractive than equity or vice versa, then also switching can be done.
5) Trigger disappears
All investments are done on the basis of some underlying trigger which the investor expects to happen. The triggers can be of many hues like expectations of high growth, PE rerating, expected higher margins due to low input costs, lower competitive intensity due to pollution issues in China, anti-dumping duty imposition or continuation, etc.
If this trigger disappears or is diluted then the rationale to hold the investment becomes shaky and needs a relook.
These are by no means the only reasons to sell nor are they foolproof. But they do help in making better decisions. Sometimes the strategies will backfire and sometimes FOMO will prevent their execution. But I personally find it better to book profits and be sorry than to make losses.