InvestorQ : What are the key triggers to sell as stock and how to use such triggers to decide whether to sell the stock or not?
Mahima Roy made post

What are the key triggers to sell as stock and how to use such triggers to decide whether to sell the stock or not?

Aditi Sharma answered.
3 years ago

There are different triggers to sell a stock, which can be fundamental, technical or even purely news driven. Traders and investors understand buy signals quite well but they falter in identifying the sell signals. Interestingly, the big realty is that you only make money when you sell and hence fine tuning your selling triggers and response mechanism becomes extremely important. You should first consider the fundamental factors that induce to sell the stock and then ratify it with technical signals. However, it can also be the other way round wherein the technical charts give you the first signals. Let us look at some interesting signals for selling in the markets.

Rising bond yields are a classic trigger to sell

Higher bond yields are normally an outcome of rising inflation. We saw that trend in India between June 2018 and November 2018 when the RBI also hiked the repo rates by 50 bps and yields got as high as 8.3% on the 10 year benchmark. Why do higher bond yields matter to equities? That is because, it is an indication of rising cost of funds and that can have negative implications for companies. Rising yields also mean that future cash flows will be discounted at a higher cost of capital.

If liquidity is getting tight, you must run for the exits

Indian equity markets love abundant liquidity and usually bull markets are driven by liquidity. Therefore, the reverse should also hold true. When liquidity tightens, yields on the short term instruments also start to go up. These include the CPs, CDs, call money etc. When the short term bond yields rise faster than the long term bond yields due to liquidity tightening, the yield curve takes an inverted shape. This indicates pessimism over the longer term and is a clear bearish signal. When liquidity is tight as we saw after the two rate hikes in mid-2018, most investors run for the exits!

Fundamentally, focus on how working capital is being managed by the company

Focus on companies with positive working capital with current assets more than the current liabilities. Negative working capital is when the current liabilities are more than the current assets. That is when the company has to rely on long term assets to meet the current liabilities. That is a clear case for a maturity mismatch between assets and liabilities. Apart from just looking at the net working capital, the investor must also look at the quick ratio. This considers current assets excluding inventories. The advantage is that you get a clearer picture of liquidity. A majority of the business failures in the Indian context are an outcome of bad working capital management.

Is the company paying too much to service its debt?

Now look at cost of funds. This problem can be clearly seen from the trend of the interest coverage ratio. You can also look at the overall debt service coverage ratio rather than just the interest coverage. If falling interest coverage is accompanied by falling net and operating profit margins, it is a signal of deteriorating financial health of the company. Time to call it quits!

Look at the CRISIL ratio of upgrades to credit downgrade

This captures industry trend quite precisely. Do we see consistent rating downgrades on the debt paper of a specific industry? This is an example of strained financials and limited capacity to service the debt. This can be an extension of the previous point but at a sectoral level this can be an important exit signal. Also look at the trend if the ratio is deteriorating as has been happening since the middle of 2019.

Is the Nifty or the sectoral index falling with rising volumes?

Market peaks of 2000, 2008 and 2010 were followed by prolonged periods of market correction. Normally, a correction of 8-10% can be seen as a normal halt in the up-trend. A correction of more than 15% supported by higher volumes and price damage in front line stocks is a clear indication that all is not well. It is time to sell out in a larger context. Take that as a cue and walk out right away.

When P/E ratios are closer to historic peaks and way above average P/E

This may not always work but it is better to be safe than absolutely sure. The best way to deploy this measure is to use peer group benchmarks. If the company valuations are out of line with peer group valuations and if financials are also deteriorating; then it means that the margin of safety is negative. Such stocks are best sold out of.

The beauty of the markets is that no correction happens suddenly, including the massive meltdown of 2008. They had enough indications for more than 6 months before the actual meltdown came. It is jut that you need to keep an open mind.