Subject: Strategy - When to Buy/Sell Stocks
Last-Revised: 25 Nov 1993
Contributed-By: Maurice Suhre
This article presents one person's opinions on when to buy or sell stocks. Your mileage will certainly vary.
- Stock XYZ used to trade at 40 and it has dropped to 25. Is it
a good buy?
A: Maybe. Buying stocks just because they look "cheap" isn't a good idea. All too often they look cheaper later on. (Oak Industries, in Cable TV equipment, used to sell in the 40s. Lately, it's recovered from 1 to 3. IBM looked "cheap" when it went from 137 or so down to 90. You know the rest.) Wait for XYZ to demonstrate that it has quit going down and is showing some sign of strength, perhaps purchasing in the 28 range. If you are expecting a return to 40, you can give up a few points initially. Note that this situation is the same as trying to sell at the top, except the situation is inverted. See the comments on "base building" in the Technical Analysis section of the FAQ.
- I'd like to sell a stock since I have a good profit, but I don't
want to pay the taxes. What should I do?
A: Sell the stock and pay the taxes. Seriously, if you have profits, the government wants their (unfair) share. Their hand (via the IRS) is in your pocket. If you don't make any money, then you won't owe the government anything.
- I have a profit in a stock and I want to sell at the exact top.
A: If anybody knows how, they haven't told me. Some technical indicators such as RSI can be helpful in locating approximate local maxima. Fundamental valuation ratios such as price/earnings or price/book can suggest overvalued ranges.
- What are some guidelines for selling when you have a profit?
A: Since you can't pick the exact top, you either sell too soon or too late. If you sell too soon, you may miss out on a substantial up move. If you sell too late, then you will preserve most of the last up move (unless you get caught in some sort of '87 type crash). One mechanical rule advocated by Jerry Klein (LA area) is this: If you have at least a 20 percent profit, use a (mental) stop to preserve 80 percent of your profit. The technical analysis approach is to determine a prior support level and set a stop slightly below there. Marty Zweig's book has an excellent discussion of trailing stops, both in setting them and how to use them.
- It seems like stocks often drop excessively on just a little bit
of bad news. What gives?
A: One explanation is the "cockroach theory". If you see one cockroach, there are probably a lot more around. If one piece of bad news gets out, the fear is that there are others not yet public. Similarly, if one stock in a group gets into trouble, there is a suspicion that the others might not be far behind.
- I saw good news in the paper today. Should I buy the stock?
A: Not necessarily. Everyone saw the news in the paper, and the stock price has already reflected that news.
- I don't want to be a short term trader. Can one of these computer
programs help me for the long term?
A: Possibly. If you have decided to buy and the stock is still declining, a computer could help determine when a local bottom has been reached. This sort of technical analysis is not infallible, but the computations are somewhat awkward to do by hand calculator. These programs aren't free, downloading the data isn't free, and you will have to do some study to understand what the program is telling you. If you are more or less ready to sell, the program may be able to locate a local top. Ask your broker if he is using any kind of computer analysis for buy/sell decisions. If you already own a PC, then an analysis program might be cost effective.
- How does market timing apply to stocks? (I understand about
switching mutual funds using market timing signals).
A: Assuming that you think the market is "too high", you might a) tighten up your stops to preserve profits, b) sell off some positions to capture profits and reduce exposure, c) sell covered calls to provide some downside protection, d) purchase puts as "insurance", e) look for possible shorting situations, and/or f) delay any new purchases. If you think the market is "too low", then you might a) commit reserve money for new purchases and/or b) take profits from prior shorting.
- Explain market action, group action, and individual stock action.
A: Every day, some stocks go up, some go down, and some are unchanged. Market action applies to the general direction of the market. Are most stocks going up or down? Are broad averages (S&P 500, etc.) going up or down? Group action refers to a specific industry group. Biotechs may be "hot", technology may be "hot", out of favor groups may be dropping. Finally, not all companies within a rising group will be doing equally well -- some individual stocks will have risen, some won't, some may even be sliding lower.
- How do I use this information (assuming I've got it)?
A: A strategy is to locate a rising group in a rising market. Look for good companies in the group which haven't risen yet and purchase one or more of them. The assumption is that the "best" companies have already been bid up to full value and that some of the remaining will be bid up. Avoid the poorest companies in the group since they may not move at all.
- Should I look at a chart before I purchase a stock?
A: Definitely. In fact, raise your right hand and repeat after me: "I will never purchase a stock without looking at a chart". Also, "I will never purchase a stock in a Stage 4 decline." (See technical analysis articles in this FAQ for details.) If you have a full service broker, he should send you a chart, Value Line report, and S&P report. If you can't get these, you aren't getting full service. Value Line and S&P are probably available in your local library.
- Do I need to keep looking at charts while I am holding my
A: Probably. You don't necessarily need to look a charts on a daily basis, but it is difficult to set trailing stops [ref 1] without looking at a chart. You can also get information about where the price is relative to the moving averages.
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