When to sell a stock: Key Signals to Sell Your Winning Stock - Rich Mindset and You

The final chapter of book "How to Master Charts and Manage Your Portfolio" by John Murphy focuses on a critical aspect of investing: knowing when to sell your winning stocks. As Murphy notes, selling your winning stocks can be just as important as buying them in the first place. By taking profits at the right time, you can maximize your returns and avoid potential losses.

Murphy outlines several key factors that investors should consider when deciding whether to sell a stock. These factors include a stock's climax top, valuation, technicals, and the investor's overall investment goals and risk tolerance.

Identifying a Climax Top: Key Signals to Sell Your Winning Stock

What is a Climax Top? 

A Climax Top occurs after a huge price move over many months after the stock is extended out of its last base. It is a sign of extreme euphoria and typically occurs in the late stages of a bull market. Eight out of ten of the Best of the Best topped this way.

Key Signals to Look for When Identifying a Climax Top

Rapid price move: Look for a rapid price move of 25% to 50% in 3 weeks or less. This rapid move is a sign of extreme euphoria and often indicates that the stock is overvalued.

Largest daily price run-up: Another key signal to look for is the largest daily price run-up since the beginning of the whole move up. This is another sign of extreme euphoria and can indicate that the stock is overvalued.

Exhaustion Gaps: Exhaustion gaps occur when the stock has extended over 100% above the 200-day moving average. This is a sign that the stock is overbought and may be due for a correction.

Recent Stock Split: A recent stock split can also be a sign of a Climax Top. Look for 7 out of 8 days up or the largest weekly price spread. These are signs of extreme euphoria and overvaluation.

Railroad tracks and island tops: Another signal to look for is railroad tracks and island tops. These occur when the stock gaps up and then gaps down, leaving a space in the middle of the chart. This is a sign of extreme euphoria and often indicates that the stock is overvalued.

Signs of Weakness: Signs of weakness can also be an indication of a Climax Top. Look for heavy daily volume without further upside price progress. This is a sign of distribution and can indicate that the stock is overvalued. Other signs of weakness include a new high on low volume, poor rally in light volume, and lagging relative strength.

Faulty base structure: A faulty base structure can also be a sign of a Climax Top. Look for a two-weeks down, then two weeks up pattern, a 3rd, 4th, or 5th stage base, or a change of trend. These are signs that the stock may be overvalued and due for a correction.

Uptrend broken: Finally, the uptrend being broken can be a sign of a Climax Top. If the stock continues to trade below the 50-day moving average, or there is a largest one-day price drop, this could be an indication that the stock is overvalued and due for a correction.

Some Other Factors

Valuation 

The first factor to consider when deciding whether to sell a stock is its valuation. A stock's valuation reflects its current price relative to its earnings, assets, and other financial metrics. If a stock becomes overvalued, it may be time to sell. Overvalued stocks may be priced too high relative to their underlying financial performance, which can make them vulnerable to a price correction.

One way to assess a stock's valuation is to use metrics like the price-to-earnings (P/E) ratio or the price-to-book (P/B) ratio. The P/E ratio compares a stock's current price to its earnings per share, while the P/B ratio compares a stock's current price to its book value per share. If a stock's P/E or P/B ratio is significantly higher than its historical average or the average for its industry peers, it may be overvalued.

Another way to assess a stock's valuation is to look at its dividend yield. If a stock's dividend yield falls significantly below the average for its industry or historical norms, it may be overvalued. This is because investors are willing to pay a premium for stocks that offer high dividend yields as a sign of financial stability and strong financial performance.

Technical Analysis 

The second factor to consider when deciding whether to sell a stock is its technicals. Technical analysis involves studying a stock's price chart to identify patterns and trends that can provide insights into its future price movements.

One of the key principles of technical analysis is the idea that history tends to repeat itself. As Murphy notes, a stock's price chart can provide valuable insights into its future price movements based on its past performance.

Some of the key technical indicators that investors can use to assess a stock's future price movements include moving averages, support and resistance levels, and chart patterns like head and shoulders or double bottoms.

Moving averages are a commonly used technical indicator that can help investors identify trends in a stock's price movements. Moving averages are calculated by taking the average of a stock's closing prices over a specific period, such as 50 or 200 days. If a stock's price is above its moving average, it is considered to be in an uptrend, while if its price is below its moving average, it is considered to be in a downtrend.

Support and resistance levels are price levels on a stock's chart where buying or selling pressure is particularly strong. Support levels are price levels where buying pressure is strong enough to prevent the stock's price from falling further. Resistance levels are price levels where selling pressure is strong enough to prevent the stock's price from rising further. If a stock's price breaks through a key support or resistance level, it can be a sign of a trend reversal.

Chart patterns are another tool that investors can use to identify potential trend reversals. Chart patterns are formed when a stock's price movements form a recognizable shape on its chart. For example, a head and shoulders pattern is formed when a stock's price forms three peaks, with the middle peak (the "head") being higher than the other two (the "shoulders"). This pattern is considered to be a bearish signal, indicating that the stock's price is likely to reverse trend and start falling. Conversely, a double bottom pattern is formed when a stock's price hits a low, bounces back up, then falls back down to hit the same low again. This pattern is considered to be a bullish signal, indicating that the stock's price is likely to reverse trend and start rising.

While technical analysis can provide valuable insights into a stock's future price movements, it is important to use it in conjunction with other factors, such as valuation and fundamental analysis.

Investment Goals and Risk Tolerance 

The final factor to consider when deciding whether to sell a stock is your overall investment goals and risk tolerance. As Murphy notes, different investors have different investment goals and risk tolerance levels, which can influence their decision to sell a winning stock.

For example, if your goal is to maximize your returns in the short-term, you may be more inclined to sell a stock once it has reached a certain price target or has become overvalued. On the other hand, if your goal is to build a diversified long-term portfolio, you may be more willing to hold onto a winning stock for a longer period of time, even if it becomes overvalued in the short-term.

Similarly, your risk tolerance can influence your decision to sell a winning stock. If you have a low risk tolerance and are uncomfortable with the potential for a price correction, you may be more inclined to sell a stock once it has reached a certain level of profitability. On the other hand, if you have a higher risk tolerance and are willing to weather short-term fluctuations in a stock's price, you may be more willing to hold onto a winning stock for a longer period of time.

In addition to these factors, Murphy also provides some practical tips for selling your winning stocks. These include:

Don't be too greedy - While it can be tempting to hold onto a winning stock for as long as possible in order to maximize your profits, it is important to be realistic about the stock's future prospects and valuation.

Set price targets - Before you buy a stock, set a realistic price target for when you will sell it. This can help you avoid being swayed by short-term price fluctuations and can provide a clear exit strategy for when the stock reaches its target price.

Keep an eye on the fundamentals - While technical analysis can be helpful in assessing a stock's future price movements, it is important to also keep an eye on the company's underlying financial performance and industry trends.

Rebalance your portfolio regularly - Regularly rebalancing your portfolio can help you manage risk and ensure that your investments are aligned with your investment goals and risk tolerance.

Conclusion Knowing when to sell your winning stocks is a critical aspect of successful investing. By taking profits at the right time, investors can maximize their returns and avoid potential losses. In "How to Master Charts and Manage Your Portfolio," John Murphy provides valuable insights and practical tips for assessing a stock's valuation, technicals, and overall investment goals and risk tolerance when deciding whether to sell a winning stock. By considering these factors and implementing a disciplined approach to selling winning stocks, investors can increase their chances of long-term investment success.