By HarmonyAndHappiness

Is it because the stock has risen and you want to secure the profits by selling, or is it because it has fallen and you want to cut your losses by selling?

In fact, we are all quite fortunate that the investment guru and 'Oracle of Omaha,' Warren Buffett, has already provided us with an answer to this question. He advises never to sell the stocks in your possession unless you encounter one of three situations. If you've just learned about these three reasons to sell stocks, you might realize that you've been doing it all wrong before.

If you do own stocks, you might have sold off a portion and are sitting on some cash, hoping to buy more. However, as the stock market continues to rise, there are no cheap opportunities to buy in, and more and more people are afraid that the market is at a high and are gradually cashing out.

So, what exactly should we do? Actually, it depends on what kind of investor you are. If you are a short-term trader or someone who invests for a year or two to make some money for buying a house or getting married, or if you want to invest for the long term, the answer will be completely different.

Before explaining Buffett's three reasons for selling, we still need to understand what kind of investor we are in order to find the most suitable answer. Let's talk about active trading first. Active trading refers to short-term stock speculation, focusing on quick in-and-out trades. The faster and more frequent the trading, the higher the potential short-term returns might be, but the risks are also greater, requiring a stronger psychological resilience.

Firstly, scalping, also known as "snatching the cap," sounds rather intimidating but is quite descriptive. This style is the fastest and shortest of all active trading strategies, with transactions lasting only a few seconds to a few minutes. Traders aim to accumulate profits through frequent large transactions to capitalize on small gains. This was once the domain of professional traders, but with the advent of automated quantitative trading, scalping has become a battleground for algorithmic models. This game is no longer for humans to play.

Secondly, day trading involves buying and selling positions within the same day, avoiding holding positions overnight. Traders capitalize on daily news, such as central bank interest rate meetings, corporate earnings reports and forecasts, or even new trade agreements. It is more suitable for professional individuals for whom trading is a full-time job. Imagine the kind of life where one sits in front of four computer screens displaying candlestick charts, too engrossed to even take a bathroom break.

Thirdly, swing trading involves holding positions from several days to several weeks, capitalizing on short-term stock trends. Swing traders typically look for stocks with significant volatility. The terms we often hear, such as resistance levels, support levels, and moving averages, are technical aspects commonly encountered in swing trading. Many friends who work full-time and wish to dabble in short-term trading usually engage in swing trading.

The current market is quite suitable for this type of trading due to its instability and significant fluctuations. The target stocks also vary, such as trading AI stocks one week, nuclear power the next, and new energy sources the week after. Would these traders be afraid of a market that's too high?

Actually, no, because experienced traders will hedge their risks and are psychologically prepared for the consequences. Active trading is a bit like rowing in the sea; the more people on the boat, the more rowers there are, and the faster the boat goes. However, since there's no captain steering, any internal issue among the crew can lead to some disembarking. If the number of rowers on either side becomes unbalanced, the boat will veer off course and drift farther from the destination.

If you're the first to disembark before the boat veers off course, then you're quite lucky, but you'll need to jump onto another boat headed towards the destination to continue forward. However, many people only leave the boat long after it has deviated from its path, nearly back to the starting point. In that case, there's no choice but to start over, having made no progress. Active investing is very different from active trading. It typically involves an experienced investor or fund manager who restructures and optimizes the investment portfolio.

Based on the fund manager's judgment, they may engage in short-term trading, hold positions for the medium to long term, or even use leverage to short sell, aiming to provide investors with returns that exceed the market average, while also charging high management fees. Active investing is like hiring a skilled captain for the ship; the speed and direction of the journey are controlled by the captain.

All you need to do is lie back and relax, but you have to buy a ticket, and it's not cheap; you're charged based on the distance traveled. If the captain navigates well, you stay aboard longer; if not, you can choose to disembark. However, the captain doesn't guarantee a fast journey, nor proximity to the destination, and the ticket is non-refundable.

If you are an active investor, you need to pay attention to the fund manager's moves. If you think they have made a wrong judgment, you should disembark in a timely manner. But then again, didn't you entrust your money to a fund manager because you didn't want to manage it yourself? As such, most people who disembark from active investing do so only after they have lost too much money and realize they must give up passive investing.

Passive investing spans a longer period than all the trading or investing methods mentioned above. The classic passive investment strategy is to buy and hold indefinitely, never selling. This strategy has little to do with technical analysis and is mainly based on company valuations and economic fundamentals.

In terms of investment vehicles, index funds and ETFs are common choices, and some investors simply hand their money over to Buffett, as he is the most formidable figure in the realm of passive and long-term investing. Passive investing is like getting on a massive cruise ship where tickets are cheap, the course is set, and you can just lie back and relax without affecting anything.

This ship may move a bit slower than others, but it's steady. Historically, it has a higher probability of reaching the destination before those actively steered by captains. If you are an active investor, you need to learn professional technical analysis and improve your psychological resilience and sensitivity to market fluctuations to master the timing of selling.

I myself belong to another category of investors who prefer the "big ship" approach — long-term and passive investing. Buffett is the best of all captains, and once you're on board, the course is set; he never stops and rarely changes direction. If you are a passive investor or focused on the long-term, then you're in luck. Because when to sell? Buffett has systematically summarized this, and we'll take a look at what the wise old Buffett has to say.

Before discussing the three situations in which you should sell stocks, let's first look at why stock price movements — whether upward, downward, or stagnant — should not be reasons to sell. It's because we pay too much attention to the purchase price.

Buffett has said: "One of the important things in stocks is that the stock doesn't know that you own it. You have all these feelings about it; you remember what you paid, who told you about it, all these little things. It doesn't care — it just sits there. If a stock is at fifty and somebody's paid a hundred, they feel terrible; somebody else paid ten, they feel wonderful. All these feelings have no impact whatsoever."

So, if stock price fluctuations or stagnation shouldn't influence your decision, what should be the basis for deciding to sell? Firstly, a better investment opportunity arises. Buffett's first scenario for wanting to sell stocks is the emergence of a better investment opportunity.

Buffett said, "The first twenty years of investing, or maybe more, my decision to sell almost always was based on the fact that I found something else I was dying to buy. I mean, I sold stocks at three times earnings to buy stocks at two times earnings forty-five years ago."

If you've invested in company A's stock, you can't put the same money into company B's stock; this is your opportunity cost. Therefore, selling a stock requires giving up a good company you're currently invested in, obtaining cash, and then using it to buy stock in an even better company.

This example comes from a letter Buffett wrote to his shareholders in 1959, where he described the process of converting his holdings in Federal Trust into shares of another company in the surveying business: "At year-end, we found a good opportunity to become the largest shareholder of the surveying company at a very cheap price. So, we sold the Federal Trust stock at $80 per share to raise funds. What I want to say is that the buyers who purchased our stocks at $80 can expect a pretty good return in the coming years. However, the price of $80 for Federal Trust compared to its intrinsic value of $135, and the surveying company's price of $50 compared to its intrinsic value of $125, are significantly different. Capital can be more effectively utilized when it is reallocated."

Secondly, Buffett would sell stocks when the fundamentaleconomic characteristics of a company change. If there is a significant shift in what made the business an attractive investment in the first place, it may prompt a decision to sell.

Buffett stated, "My inclination is not to sell things unless we get really discouraged, perhaps with the management, or we think the economic characteristics of the business change in a big way. And that happens."

Let's look at a few examples where Buffett sold stocks due to changes in a company's economic characteristics. In 2020, he sold shares in several major airlines, noting that the world had changed for the aviation industry due to the spread of COVID-19. In 2014, Buffett sold one of his most significant investments ever, The Washington Post. Over the years, Buffett had spoken about the changing business world for newspapers, and The Washington Post no longer possessed the competitive advantage it had when Berkshire Hathaway first bought it in 1973. After 40 years, Buffett decided to sell. Another example is Buffett's investment in the grocery chain Tesco. Buffett had opinions about the company's management, which might have been the real reason he ultimately sold his shares. By 2014, he had completely divested his holdings, taking a small loss. However, situations where a business or its economic circumstances fundamentally change are not frequent. Buffett clarified this in his 1997 annual letter to Berkshire Hathaway shareholders, stating that selling a quality business due to alarming news is usually a bad decision.

Thirdly, an investment becomes too large a portion of the portfolio. When a single stock occupies too large a percentage of one's investment portfolio, it's necessary to sell. This is what people often mean when they say, "Don't put all your eggs in one basket." The smaller your investment portfolio, the more it can be concentrated in a single stock, but as the portfolio grows, you must consider diversifying risk. In 1967, the funds Buffett managed were equivalent to $500 million in today's value, and at that time, he had invested 40% of his capital in American Express stock. However, as the stock appreciated and other stocks relatively underperformed, American Express came to occupy more than 40% of the investment portfolio. Buffett decisively began to reduce his holdings to maintain some diversification.

After discussing so much, let's summarize: If we are long-term investors, we absolutely should not sell stocks just because their prices rise, fall, or stagnate. The reasons for selling should be: firstly, a better investment opportunity arises; secondly, the fundamental economic characteristics of the business change; and thirdly, an investment becomes too large a portion of the portfolio. However, after Charlie Munger joined Berkshire Hathaway and became Buffett's partner, Buffett's investment logic changed, especially regarding the first reason for selling stocks. Now, even if the performance of the stocks he holds lags slightly, Buffett will not sell because he always has a large amount of cash on hand. He doesn't need to sell stocks to free up cash to buy better ones, so we shouldn't invest all our money in the stock market. We need to keep a certain amount of cash available so as not to miss opportunities.