If anyone ever comes up with the perfect time to buy and sell stocks, that person will own the world. Right now, timing-based stock trading is based on premises only slighly better than magic. There are, however, some good rules of thumb that you can follow which will help you find the best times to sell your stocks high, and when to cut them loose when they start to drop.
The very most important thing in investing, no matter what your goals, is to know the true worth of the company you're invested with, and to keep track of that worth. You should only buy a stock when it falls below the company's true value, and then sell it when it seems overinflated compared to that value.
To find those times to buy, look for situations where a company's stock price is artificially low compared to its value. But the best time to sell is when you think a stock is overpriced and will not quickly grow into its overvalued price. Watch your stocks as they rise and compare the market value to what you think the real value is. One of the rules of the stock market is that whatever rises, tends to continue rising past where you think it should stop (its called “everyone jumping on the bandwagon"). When a stock hits a point where you are sure that it is significantly overvalued, sell.
Buying stocks cheap takes the opposite approach. Only buy stocks that are cheap but which you think are undervalued and likely to significantly increase in price in the future. Stocks can only be purchased cheap by recognizing two facts. First, over the long term, the market is rational, and stock prices will reflect a company's value. But second, in the short-term, stock prices may undervalue or overvalue a stock. Finding stocks when they are undervalued is the key. But remember, most of the time stocks are selling for close to their real-value. So, most of the time, stocks are trading close to what they're worth. This gives you reason to be skeptical of stocks with low P/E ratios. But sometimes, low P/E ratios when combined with strong growth and market share gain, can indicate a buying opportunity.
The moral of the story is that you need to have a sense of what you think a company’s stock is worth before you buy and sell it. Just like you need to have a sense of how much a home is worth before you buy and sell a home. Part of the equation is going to be relative to the market, but part of the equation has to do with business fundamentals and how well the company is poised for future growth. If you see a company without a clear vision for how to run its business, then sell the stock before the consequences of poor management hit Wall St. If you see a good company that is way overpriced compared to its ability to grow, again, take your profits. If you see a company that has huge opportunities for business growth but which is undervalued either because investors haven’t properly recognized it yet, or because they’ve unfairly punished it, look to buy.
Quentin James writes articles on personal finance for The Common Sense Investor . His latest series of articles focuses on retirement investing and tax efficiency .