4 guidelines for taking profits
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To the extent that any content below constitutes advice, it is general advice (or, in New Zealand, a "class service") that has been prepared by Lesley Beath as a Morningstar authorized representative (ARN 469614) without taking into account your particular investment objectives, financial situation or needs. If necessary, you should consider the advice in light of these matters, consult with a licensed financial advisor, and consider the relevant Product Disclosure Statement (Australian products) or Investment Statement (New Zealand products) before making any decision to invest. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.
Last week we looked at the importance of cutting losses. We all know that cutting losses is one of the most important factors in successful investing, but at times human emotion prevents us from the ability to be disciplined in our loss-taking.
Just as the human emotion of "hope" can at times prevent us from cutting our losses, "greed" can stop us from taking profits on successful positions.
The Australian market has enjoyed an amazing run over the past few years, with many stocks giving investors returns far beyond their expectations -- for those lucky (or smart) enough to own these stocks, the rewards have been substantial.
It is always a difficult decision to take profits in a stock that is constantly moving higher and the old saying "cut your losses and let your profits run" is a very true investment option.
So how do we decide when to cut back our holdings in some of these star performers?
The answer to this is not easy and many investors will sell their stocks only to see them double or triple after they have been sold -- this can be extremely frustrating.
So what discipline can we use to make sure that we don't sell too early or that we don't make the mistake of hanging on for too long?
As I have outlined on many occasions, momentum indicators do not work well in trending markets -- just as the stochastic or any other momentum indicator can "run along" at extremely oversold levels, the opposite is true in a fast-moving market.
Using these indicators in isolation is fraught with danger. There are many chart patterns and price behaviours that will indicate when a stock is nearing a peak and technical analysts will spend hours looking for such conditions, but the average investor may not have the time or the experience to look for such patterns.
This week we will focus on a few practises that can assist in our decision-making process. They are not infallible, but if we stick to a disciplined approach we are more likely to be successful in our investing.
There is always the chance that price will keep moving higher after we have taken some profits, but as with cutting losses, this is all part of the investment process. It would be great if we could buy or sell at the lowest or highest price, but in reality that very rarely happens.
There are four guidelines, and I stress the word "guidelines," that we can utilise to determine when we should lighten up on an individual stock.