Knowing when to get into stocks is super important, no doubt – but just as important is knowing when to get out. Have you mastered the art and the science of profit taking?
Profits Are the Name of the Game
It’s hard to imagine that anybody in the investing game doesn’t have one ultimate objective in mind: to make profits. (Harvesting tax losses might be an exception, but that’s a tale to be told another day…) Yet, to make profits you’ve got to take profits, and that’s a topic that merits its own set of guidelines, which is precisely what this blog posting is all about.
It’s an aspect of trading and investing that’s often ignored, as it’s not as “sexy” (immediately appealing) as, say, a tutorial on “how to pick hot stocks” or “finding the magic technical indicator.” Nonetheless, understanding when to take profits in stocks is just as important as those topics – indeed, perhaps even more so.
Don’t Wait ’til it’s Too Late
There are a number of things you’ll want to establish before you place a trade in the stock market, and your exit strategy definitely falls into that category. The time to start thinking about when to take profits on a trade is not after you’ve placed the trade; that’s a sure path to trouble, which I’m trying to help you avoid.
I’ve seen far too many real-life examples of folks to enter into a stock trade or investment, having thought carefully about when and how to get into it. That’s all fine and good, but with no exit plan, they end up second-guessing themselves as the stock price flops around. The upshot is typically a hesitant, unsure, or even panicked exit at an unfavorable price.
Therefore, I view it as an absolute necessity to plan your profit-taking strategy beforehand. Once you’ve developed the habit of preplanning your exits, it will become a natural part of your overall trading or investing methodology.
What’s Your Time Frame?
Your profit-taking plan depends largely on your time horizon: if you buy the stock shares, how long would you be willing to hold onto them? There’s no right or wrong response to this: whether you intend to hold your shares for five minutes, five weeks, five months or five years is a personal decision to make. But regardless of which time frame you choose, you must have some idea of your time frame for the trade in order to formulate a solid profit-take strategy.
When you define your preferred time horizon for a trade, then at least you’ll know one thing: you intend to take profits within that time frame. So, for instance, a day trader will know that he or she will take profits (or losses) on or before the end of the trading day. In contrast, a Warren Buffett-style long-term investor will know that he or she will hold onto the stock, regardless of its price action, for years. This is key because it prevents unnecessarily early profit taking, which can be destructive to anyone’s portfolio.
Stop-loss, or No Stop-loss?
There’s no right or wrong answer to whether one should use a stop-loss as part of his or her profit-taking strategy: like the time horizon issue, the decision to use stop-loss orders or not is a personal one. Still, this is a decision that should be made before purchasing stock shares, and if a stop-loss order is used, it should reflect how much financial “pain” the investor is willing to accept.
Financial “pain” is an interesting concept: how much of a loss are you willing and able to tolerate before exiting the trade? For very long-term investors, the pain might not matter so much, and so a stop-loss may be entirely unnecessary. For short-term traders, on the other hand, knowing how much pain one can take is pivotal to finding the best place for a stop-loss order.
Don’t Get Emotionally Attached
Besides knowing one’s time horizon and establishing a stop-loss strategy (if needed), investors should base profit-taking on the overall health of the stock and the company. If you ever decide that a company is failing and beyond hope of recovery, it’s probably time to consider taking profits (or losses, as the case may be).
Remember, you can always re-enter your position in the stock at a later time. Avoid emotional attachments to stocks and companies, and take profits as soon as the market gives you a good reason to do so.
Enjoy Your Profits!
The preceding guidelines have provided you with a rough idea of when to “take the money and run,” so to speak. So, by all means, enjoy those profits that you’ve taken – you’ve certainly earned them!