The textbook approach to buying and selling stocks is much more difficult than what investors typically do in the real world. The prescription for investment success is to buy low and sell high but the typical investor tends to do the opposite.
Stocks should typically be bought in two situations. In order to achieve long-term goals, stocks should generally be bought as soon as possible. More tactically, stocks should also be bought in the middle of a market correction or bear market.
Stocks should be sold when there is an immediate liquidity need, if your circumstances have changed, for realizing capital losses, or if a company’s circumstances change.
Two critical steps before even thinking about buying and selling stocks include establishing a long-term financial plan and agreeing to remove emotions from the investment process. 2 out of 3 investors end up regretting emotional and impulsive investment decisions.
Emotions and Biases in Investing
The main impediment to investment success for almost all investors is the involvement of emotions and biases when investing.
If emotions were to be removed from the investment equation, and a great financial plan and portfolio were in place, a lot more people would have great long-term investment success.
Some biases that can lead to investment mistakes include:
- Confirmation bias
- Hindsight bias
- Anchoring bias
We’ll cover when to buy and sell stocks in Canada below and outline how to properly put your money to work for you.
When to Buy and Sell Stocks in Canada
Buying a Stock
Determining when to buy a stock is actually less difficult than finding out when to sell. Once you have set up an investment plan and assessed that a stock or group of stocks is appropriate for you, your time horizon will be the main factor behind when to buy a stock.
If you are investing over a long-term or very long-term time horizon, the best time to buy a stock is generally as soon as possible. Putting your money to work sooner rather than later gives you more time in the market and increases your chances of outperforming inflation over the long term.
If you are investing over a shorter time horizon, stocks may not be an appropriate investment vehicle. Shorter time horizons may require dollar-cost averaging or using technical indicators for buying a stock.
Dollar-cost averaging is a strategy that you can use to buy any investment, including stocks. It is especially valuable when markets are very volatile because it can help reduce the impact of short-term volatility.
Consider the following two scenarios:
Scenario 1: You invest $120,000 today into stock A
Scenario 2: You invest $10,000 per month into stock A over the course of a year
Scenario 1, which involves a lump-sum investment, is more advantageous if the market rises consistently over the course of a year.
Scenario 2, which outlines dollar-cost averaging, can offer a lower cost if markets are volatile towards the downside.
An additional thing to keep in mind, if using dollar-cost averaging to buy stocks, is your cost per trade. Lump-sum investing involves one buy order while dollar-cost averaging involves multiple orders. The additional orders will likely increase your trading costs over time.
Using Technical Indicators
The usefulness of technical indicators is commonly debated in the investment world. Technical indicators involve the studying of an investment’s past trading action in order to determine where it will go next.
Although human psychology can cause patterns to emerge in stock trading, it is difficult to predict future movements based on past performance.
Technical indicators may indicate when a stock is over-bought or over-sold. It can help to reduce short-term volatility, which is especially crucial if your investment time horizon is shorter.
Some common technical indicators used in trading include:
- Simple moving averages
- Exponential moving averages
- Bollinger bands
- Relative strength indicators
If you have excess liquidity, the best time to purchase stocks is during a market correction or bear market. This will allow you to purchase stocks that you would like to hold over the long-term on sale.
Selling a Stock
The selling of a stock is significantly more difficult to determine than a stock’s purchase. Here are some of the main situations in which you would want to sell your stock position:
- You need immediate cash liquidity
- Your circumstances have changed
- You would like to realize capital losses
- The company’s current and or future prospects have changed
Immediate Cash Liquidity Needs
Selling stock to cover immediate cash liquidity needs is a fairly basic concept.
Unexpected life circumstances, such as immediate medical treatment or property damage can cause you to sell some or all of your stock holdings to generate cash.
Planned life circumstances can also cause you to sell stocks in order to raise cash. These can include reaching your retirement age or having a dependant begin post-secondary education.
If cash is an immediate requirement, there is little to plan when selling a stock. In some cases, you will want to consider whether to use market or limit orders.
Changing Personal Circumstances
An investor’s circumstances can also gradually change over time, which can cause the need to sell a stock. Some examples can include:
- Retirement age being lowered, decreasing your investment time horizon
- A decrease in your risk tolerance or your risk-taking ability
- A change in a stock portfolio’s objective
A reduced time horizon generally indicates that stock exposure should be lowered. A decrease in an investor’s ability and willingness to take risks should also lead to the selling of equities or higher-risk assets in their portfolio.
Lastly, if a stock portfolio changes from having a less important goal to a more important objective, you may want to sell stocks and purchase safer investments.
Realizing Capital Losses
In non-registered accounts in Canada, capital losses can be used to offset capital gains for tax purposes.
Net capital losses can be carried forward indefinitely to reduce your future tax liability. If you are looking to reduce your tax liability in the current year, you may want to sell stocks that are trading at a price lower than their cost.
Your capital gains in a year are calculated net of your capital losses, and this figure is then used to determine your tax liability in that year.
A Company’s Changing Future or Current Prospects
If a general market downturn is happening that has nothing to do with a company’s financials, it is rarely a reason to sell a stock.
If a company’s future growth or cash flow prospects change, it can be a reason to sell the stock. Stock analysts typically set out targets for quarterly figures such as earnings and revenue.
Slight misses of these targets don’t generally mean that anything is wrong with a company, but constant and significant misses may cause you to re-evaluate your investment thesis.
Deciding when to buy or sell a stock in Canada can depend on several factors.
Buying a stock is the easier of the two. Stocks can be bought immediately if investing with a long-term time horizon, or tactically within a market correction or bear market.
Selling a stock is more complex and can be triggered by several factors. These include needing liquidity, changing personal circumstances, changing company circumstances, and realizing capital losses.
Whether you are deciding to buy or sell a stock, it is always critical to have a financial plan in place. This should take into account your goals, constraints, and unique circumstances.