The Advantages of Selling Stocks Before They Split

At face value, stock splits shouldn't matter. When you trade one share of a $100 stock for four shares of a $25 stock, it's essentially the same thing as turning a dollar into four quarters. However, stocks that split tend to be strong performers after splitting. With this in mind, selling before a split is usually a bad decision, unless you're not positioned to hold a stock that is more likely to appreciate.

Splits and Psychology

When a stock's price goes up, its attractiveness can drop to small retail investors, as large number thresholds like $100 per share and $1,000 per share can serve as a psychological barrier. In some people's minds, a $100 share has more in common with a $150 share than a $99 one. Splitting a company's stock to keep its price in a range that is comfortable for retail investors can increase demand for the stock, potentially helping prices go higher. It also increases trading volumes, as you need to trade more shares to get the same value; this can increase interest from institutions that need to know the market can absorb the kind of high-volume trading they frequently do.

Splits and Performance

When a company's stock splits, it's usually in response to good performance. After all, if the company didn't have good earnings, its stock price wouldn't have climbed. A stock split is also a signal. When a board of directors explores splitting stock, it can mean that board members expect the company's growth to continue propelling the share price upward.

Cover Shorts

When you're short on a stock, it means that you've sold borrowed shares of it in the hope that you'll be able to buy the stock at a lower price to repay the loan. If you suspect that a stock split will make a company's stock price climb, though, it would be a bad time to be short, as you'd have to replace the shares you borrowed with more expensive ones instead of cheaper ones. As such, a coming stock split can indicate that it's time to close out your short position.

Capital Gain Strategy

If you believe that a stock will continue going up after a split, you may want to sell it long enough before the split that you can buy it back before it splits. Doing this can be a good strategy if the stock is appreciated and you can sell other losses to cancel it out. This strategy, which is related to tax loss harvesting, lets you reset your basis so it will be higher and give you the ability to pay less tax in the future. If you think future tax rates will climb, this can be an astute strategy. For example, if you sell shares that you bought at $10 for $20, you would have locked in that $10 per share capital gain at today's rates. If the stock continues to go up and your capital gains rate goes up -- either due to your income growth or to a raising of the tax rates -- you won't have to pay the higher tax on the entire gain from $10. You'll just pay it on the gain above $20.