Is it time for you to cash in on some stocks?
Some investors who got aboard the high-flying stock market when it took off a year ago have been looking for a parachute. After climbing from about 820 last August to nearly 1,250 earlier this summer , the Dow Jones industrial average was headed for lower altitudes last week. It has recovered somewhat, but the decline has made many investors anxious. Although they had little trouble deciding to buy after the bull market started, they are now asking: When should I sell?
Investment advisers have a variety of answers to this question, and their answers are often wrapped around an even greater variety of factors, including technical points, the investor's temperament and need, and any circumstances related to a certain stock or industry.
Sometimes, tax consequences play a part in the decision to sell. If the stock has been held for at least a year, and many of the stocks bought at the beginning of this bull market have been held that long by now, any profits qualify for the easier tax treatment accorded long-term capital gains.
Often, selling a stock that is not doing well is more painful than the decision to part with the cash to buy it in the first place. This can be true for brokers, too. There's a matter of pride involved here; no one wants to admit he made a bad choice, whether it's the investor who bought the stock or the broker who recommended it. If you just hang on to the stock a little longer, the reasoning goes, maybe it will come back and fulfill all those promises.
Of course, in this bull market the promises may have been more than fulfilled when the stock peaked, and that leads to one often-used rule for deciding to sell. That is, sell any stock that drops more than 10 to 15 percent from its peak, no matter how much you liked it when when you got in. With more volatile stocks, such as those on the over-the-counter markets or the American Stock Exchange, you may want to increase the limits to 20 or 25 percent.
Financial advisers who favor this strategy admit it may be a mistake sometimes: a stock can turn around and go up again. But overall, they say, following this policy will prevent a greater loss.
One broker, asked about his criteria for selling, also had what he called a fairly simple rule: ''I decide when I'm going to sell before I buy,'' he said. After examining a company, he explained, he decides how high the stock price can realistically expect to go. Then - if it doesn't fall drastically before then - he sells when it reaches this ''ceiling.'' Again, this may mean missing some gains, but in the long run it works well for him.
While ceilings are one way to make a selling decision, many technical analysts like ''floors'' better. This is a price where previous declines in the price have ended and the stock has either held its own or gone back up again. If the stock goes below this floor, these analysts say, it means the stock is no longer attractive to investors who bought it at that price before.
Many investors, in fact, put an automatic floor in place. They instruct their broker to sell as soon as the stock gets down to that price, to make sure they don't lose any more because they were not able to catch a decline.
Beyond these ''simple rules,'' there are other, more specific ways to decide if it's time to bail out. Sometimes a stock will look attractive because the company or investment analysts following it expect a favorable development. It may be a new product, a takeover by another company, or a jump in earnings. If the expected event doesn't happen, or if it does happen and the stock still does not move, it's probably best to get out.
While an anticipated event may be a reason to buy a stock, there are unexpected events that should move you to sell. The basic fundamentals behind the company or industry, such as sales, profits, competition, or interest rates, may change suddenly. If these changes are unfavorable, sell.
Another reason to reconsider keeping a stock is the company's debt. As interest rates came down in the last year or so, many companies increased their borrowing to cover spending they were forced to defer earlier. Some companies may have overborrowed, and others may find themselves in some trouble if interest rates go back up again. With the increase in the prime rate earlier this month, this is a good time to be watching this factor.
Deciding to sell a stock that once looked so hopeful can indeed be difficult. But if investors are willing to cut their losses (or accept a somewhat smaller gain), they can avoid the pain of much greater losses, the penalty for holding on to a loser.