If you want to make profits, then learn to sell. That is an old adage in the stock markets. It is said that in the stock markets you make money only by selling. Notional profits are notional, period! The best of stock market buy decisions are pointless if you are not able to get out of the stock at the right time. That brings us to the fundamental question; when to sell a stock in the market? There are some basic guidelines that you can follow and here are a few of them that you can adopt.

How to decide your selling point when you are a short term trader?

You must be aware that traders are basically in the stock market for the very short term. They try to buy a momentum stock at a reasonable price and exit the stock when there is an opportunity. For such traders there are 2 critical levels that could trigger a sell decision. First, is the stop loss level! As a trader, you must never trade without a stop loss. It is the level at which you book loss and exit the position and is normally the technical support level of the stock. Your basic rule should be that the moment the stop loss is triggered you must simply exit your position. The second level is the profit booking level. As a trader, you must respect your stop loss levels and your profit booking levels. A smart trader is one who buys on expectations and sells on announcements.

How to decide your selling point when interest rates are headed up?

You may wonder how interest rate movements could impact the value of your equity holdings. It is one of the key factors impacting equities. You will find equities gaining value when interest rates are cut and typically losing value when interest rates are hiked. If the RBI is indicating that interest rates are headed upwards, then it is better to exit equities. A rise in interest rates will mean greater strain on borrowers and also future cash flows get discounted at a higher rate. In terms of priority, the worst hit in the event of a rate hike will be rate sensitive sectors like banks, automobiles, NBFCs and real estate companies.

How to decide your selling point when you find that FIIs are consistently selling?

Focus on the word “consistently”. In any month, there are going to be days when FIIs sell. That is more likely to be routine profit booking and you need not be worried about that. But look at situation like 2008, 2011 and 2015 when FIIs turned consistent sellers and the markets corrected sharply from these levels. FIIs will sell on a consistent basis only when they have changed their view of the Indian market for a period of time. Since these FIIs are the largest contributors to cash delivery volumes, they will have an oversized impact on markets.

How to decide your selling point when the rupee is showing signs of weakness?

This argument can actually work both ways and hence requires some clarity in understanding. Remember, a weak rupee is likely to help export-oriented sectors like software, pharma and textiles. What we are referring about here is the weakness in the rupee due to macroeconomic concerns. For example, in mid-2013 there were concerns because the current account deficit (CAD) had touched a high of 4.5% of GDP (currently the CAD is just 0.1% of GDP). This led to a run on the rupee and the INR fell from 54/$ to 68/$. This also resulted in a large scale sell-off in equities as a weak rupee wipes away the dollar gains of FIIs. When the INR gets wobbly, it is best to sell equities and exit markets.

How to decide your selling point when the industry or sector is getting disrupted?

In most cases, equities get badly impacted when the industry they are operating in undergoes a fundamental shift. At an extreme level, there are cases like the years 2000, when IT companies lost over 90% value and 2009 when real estate companies lost over 90%. These were the obvious combinations of unreasonable valuations and poor cash flow visibility. But the less obvious is of sectors going out of favour for a length of time. Capital goods went into a down cycle post 2011 and it impacted capital goods substantially. Similarly, the NPA problem has brought PSU banks into perpetual pressure zone. Telecom stocks became underperformers when the ROI just could not keep pace with the cost of debt and equity. More recently, take the case of pharma which has lost heavily as Indian pharma companies struggle to move towards an IP based model. These are all classic case studies for investors to exit stocks in that particular sector.

How to decide your selling point when the stock you are holding has corporate governance issues?

We suggest that investors should exit companies the moment there are obvious governance issues. Companies like Satyam, Kingfisher, Deccan Chronicle and Financial Technologies had serious and obvious governance issues long before the stocks went into a tailspin. This should be an early warning signal. When you see governance issues in the company you are invested in, just think with your feet. Remember, institutional investors are extremely touchy about governance issues and this can have a deep impact on the stock price.

How to decide your selling point when valuations of the stock are not justified by its expected growth rate?

This happens so often. You get into a stock an then realize that you just paid too much for a laggard. That does not feel too good but that is the time to apply the modified valuation rule of PEG or Price Earnings / Growth. Don’t go by P/E ratios and P/BV ratios alone. The question is whether the P/E ratio is justified by growth. Both IT and pharma would have failed this test a year ago. Earnings and revenues were almost flattening but valuations still remained at premium levels in case of pharma. Over the next 1 year, frontline pharma companies lost over 40% of their value. The same is happening to IT. If the numbers indicate that growth is much lower than the P/E and the ROE is less than bond yields, it is time to exit the company.

To conclude, there is really no hard and fast rule on when you should sell out of equities. There are different reasons why you may have to sell out of the stock. For example, your own financial plan may dictate that you exit the stock. The fundamentals of the stock may be showing signs of sustained and long term weakness and that is also the time to sell out of the stock. Also, you must sell out of the stock when you realize that the industry is getting badly disrupted and that could have a larger implication on the potential and the valuation of the stock.