Selling Stock: A Short Definition

Sell stock strategically to harvest profits.

Investors buy stocks to generate long-term wealth. Although investors are often primarily concerned with researching stocks to buy, knowing when to sell is equally important. When selling, investors will combine similar research and valuation metrics that are used to select stocks, alongside their respective budgeting needs to make financial decisions. Be advised that selling stock does carry important tax ramifications.

Identification

Investors sell shares of stock to take profits, cut losses and access cash as an income supplement. Investors take profits when share prices have appreciated significantly over their original purchase price. At that point, it is ideal to sell shares as their stock market value approaches and exceeds the value of the underlying business. You may research corporate annual reports for net income, assets and cash flow data to estimate business value, which may be compared to current share prices. Alternatively, some investors are forced to sell stocks at a loss, if they reason that business conditions will deteriorate further since the date of purchase. Beyond trading for the sake of profits, investors sell off shares to meet long-term financial goals, or provide cash during an emergency. Stocks may be sold to fund retirement funding and education, or to make up for lost income during job loss and divorce.

Features

The Internal Revenue Service taxes capital gains that result from your stock market sales. Capital gains identify the profits that are realized from share price appreciation. As of 2010, capital gains are categorized into short-term and long-term capital gains, for tax purposes. Short-term capital gains reference stocks that have been held for one year, or less. Short-term capital gains are taxed at 10, 15, 25, 28, 33 and 35 percent, according to your income levels. Alternatively, long-term capital gains on stocks that are held for more than one year, are either tax free or taxed at 15 percent rates. Capital losses, however, may be used to reduce your taxable income and tax liability.

Considerations

Investors may actually sell stock short, for a profit. Short selling works by borrowing shares from another investor, and immediately selling those shares for cash. At a later date, you then buy the same stock to cover and replace the original loan. You pocket the difference in value between the cash received up front, and the costs of buying shares back within the market. Therefore, short sellers make money on stocks that actually lose value.

Warning

Selling shares of stock carries opportunity cost risk. Opportunity cost risk describes foregone profits, which you would miss out on if shares continued to appreciate after your position is sold. For example, Microsoft investors who sold that stock during its early years as a public corporation may have lost the opportunity to be millionaires today.

Strategy

Investors may dollar cost average to minimize opportunity cost risk. Dollar cost averaging requires you to sell off your investment stake over longer periods of time, rather than immediately liquidating the entire share balance.

References

• Internal Revenue Service: Capital Gains and Losses
• Investopedia: Short Selling--Introduction
• Investopedia: Opportunity Cost

Resources

• Investopedia: Stocks Basics--Introduction