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How to decide the right time to exit a stock?

22 Jun 2021 0 COMMENT

Introduction:

Knowing which stock to hold and what strategies to follow succeeds the need to acknowledge the right time to sell a stock. Not getting carried away with the sentiments towards a stock and deciding based on technicalities and figures is essential. That necessitates one to carefully select both, the point of buying and selling a stock. One must correctly execute both of these decisions to make a profit.

To figure this out correctly, let us first start by knowing some basic concepts about stocks.

1. What are stocks?

A stock (also called equity) is a financial instrument that reflects ownership of a portion of a company. "Shares" are the units of stock. Investors may buy and sell individual shares of a business on the stock exchanges.

2. How does stock price move?

Before we discuss the price movement in the market, it is essential to understand the terms demand and supply in the context of capital markets

  • The term "supply" refers to the total quantity of shares available for selling at a given price.
  • The term "demand" refers to the total quantity of shares that buyers are willing to buy at a given price.

When the number of sellers (supply) exceeds the number of buyers (demand), the stock price falls. Although the price fluctuates because of demand and supply, the factors that cause a change are numerous. These include positive or negative news about a company, investor's strategy, psychological factors, company earnings, and company financials.

Additional Read: ICICI Direct- Stock market basics

3. When should I buy and hold stock?

When deciding whether or not to buy stocks, it is beneficial to be well-informed, and one way to do so is to learn about the business. Knowing more about the business will help you bring the earnings results into perspective. In doing so, consider learning the price range you are willing to buy in, the stock's valuation, and the possibility of dividends.

4. What is the right time to sell your stock?

Defining a simple market exit strategy deserves just as much consideration as the analysis you do when assessing investing in a business. To make it easier, here are a few red flags that indicate it is probably time to sell stocks.

  1. Changing fundamentals of a company:

    Keep an eye on the company's success from quarter to quarter. If you note a pause in announcing growth figures or if the company has been underperforming for a long time, it's time to pay attention. Scan for at least 3-4 quarters before making a decision. Check to see whether capacity utilization decreases (for manufacturing companies) or whether non-performing assets (for banks and other financial institutions) increase.

    Debt is also a vital predictor of a company's long-term viability. Consider the debt-to-equity ratio. A capital structure ratio compares long-term debt to long-term equity to assess a company's long-term financial viability using balance sheet data. A higher percentage implies that the company is borrowing money for a more significant portion of its funding, putting the company at risk if debt levels are too high. The lower the amount, the more stable a business is. However, if you note that this number has risen and shows no signs of decreasing, it’s time to dig deeper to analyze the other factors.

  2. Corporate governance issues of a company:

    Corporate governance measures a company's ability to maintain stakeholder relationships. As an investor, look for their transparency policy, executive pay policy, dividend plans, and a mechanism for resolving conflicts between internal and external shareholders. If a legal battle hasn't been settled, the company is in regulatory trouble, or senior executives leave abruptly, the negative effect is significant, and the stock price will drop. That should be a crucial consideration in your stock market exit plan. When a company performs poorly in corporate governance, it is challenging to recover. It's time to book profits if it fails to meet the fundamental criteria.

  3. The market behaviour:

    Sometimes the rise and fall in the price is not a result of company fundamentals or technical aspects but is caused due to investor’s sentiments. Indicators will be buoyant if the mood or market attitude is good (optimistic). A lag (pessimism), on the other hand, displays a depressed mood. To some extent, these attitudes might also help you gain a sense of the economy and aid in avoiding investors' behavioural biases.

  4. Use of Technical Analysis

    Technical analysis is also widely used to determine the target price of the stock. There are many indicators like support and resistance, RSI (Relative Strength Index), moving averages, chart patterns, etc. used by investors to plan their exit from a stock position. The study of technical analysis helps you to increase the probability of prediction of a rise or fall in stock prices.

The bottom line is that you're in the stock market to make money, and you shouldn't let your emotions rule your decisions. It's crucial to know whether to hold or sell a stock and while it's difficult to predict, some indicators will help you figure out when it's time to sell. While it's important to stick with a company you've evaluated based on its fundamentals, you should also be cautious and watch out for the red flags listed above.

Disclaimer: ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470.The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. The contents herein mentioned are solely for informational and educational purpose. Investments in securities market are subject to market risks, read all the related documents carefully before investing.