Stocks are generally considered a long-term investment since they can be volatile over the short term. However, this volatility is what encourages some stock investors to become short-term traders, in an attempt to capture a quick profit. While some traders cite the mantra that no one ever went broke taking a profit, there are some dangers involved in selling stocks quickly.
One of the biggest negatives of selling stocks quickly is that the tax rate on your profits could skyrocket. Stocks that you hold for longer than one year benefit from the capital gains tax rate, which is a special rate designed to encourage long-term investment. The capital gains rate is generally much lower than the ordinary income tax rate, which is what you have to pay if you sell your stocks one year or less after purchase. As of 2012, the highest ordinary income tax bracket was 35 percent, while the long-term capital gains rate for most investors was just 15 percent. If you are in the highest tax bracket, selling your stocks quickly results in an additional 20 percent federal tax on your profits, as of 2012.
Stocks can fluctuate greatly in price from day to day, and even from minute to minute. A stock that ultimately turns out to be a great investment may have a bad day or week at any time. If you sell too quickly when the stock trades down, you might miss a big move upwards in the future. Similarly, if you sell a stock after it moves just a few percentage points upward, you might be selling too early. Taking a profit is great, but if you sell your stock after a 5 percent gain and it goes on to double in the next few weeks, you have missed out on a great opportunity.
Some traders like to sell a stock at the first hint of bad news to avoid large losses. While this philosophy might have some investment merit, if you are an active trader it puts you at risk of triggering a wash sale. A wash sale occurs if you buy a stock within 30 days of selling it at a loss. You are certainly free to buy a stock back at any time; however, the IRS will not allow you to deduct your loss on the sale of a stock if you buy it back within 30 days of the sale.
If you buy and sell stock in a traditional, commission-based account, you must pay a commission every time you make a stock transaction. Even if you work with a low-cost or discount broker, your transaction costs can add up over time if you consistently sell stocks quickly. If you are selling your stocks quickly to take small profits, your commission cost becomes higher as a percentage of your gain. For example, if you sell your stock for a $100 commission after earning $10,000 in long-term profits, you are only paying 1 percent in commission. However, if you sell your stock after making a quick profit of $500, that effective commission rate jumps to 20 percent.
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