Getting Out With A Profit
One of the most often asked questions is this: "When should I sell?"... For some strange reason, people will take 10% profits, while they'll also sit on losers in their portfolio for months, watching them continue to fall. This is called, "limited upside, unlimited downside" investing - which is an almost guaranteed recipe for failure. So let's cover how to do it right... how to end up with big profits and small losers.
There are only TWO reasons to ever sell an investment: 1) If the reason you originally invested is no longer there; or 2) If you've hit your pre-defined "point of maximum pain." Both concepts are simple, but most people don't follow either one!
Your reason for being there is gone...
If you bought a biotech stock because its wonder drug was going to be approved by the FDA, but it wasn't approved, then it's time to sell. If you bought because you liked the CEO, and he left, then it's time to sell. If you bought for no reason other than because it was super cheap, and now it's really expensive, then what are you doing still holding it?
Why did you buy? There is nearly always a MAIN reason why you got into an investment. Go back and remember what it was... and then ask yourself if it is still there. Chances are, you'll be surprised to find how many investments you're still holding that you really shouldn't be, by this rule.
Your point of maximum pain...
The biggest killer to any portfolio is a "catastrophic loss." If a stock falls 90%, it has to rise by 900% just to get you back to where you were. So you never want to find yourself in that position, and the best rule of thumb to prevent such a debacle from happening is to use a trailing stop with every stock you own.
I like to use a 20% trailing stop with most stocks although you can be selective and vary the percentage depending on the volatility of the given stock issue. But in every case, the concept of a "stop" is simple. If a stock you own falls by 20%, you get out, and "stop" your pain. The concept of a "trailing stop" is also simple: As the stock rises in price, you raise your "stop" point. If you bought a stock at $5, and it goes to $10, then your new stop is $8.00. And if it rises to $20 without falling by 20%, then your new stop is $16.
When it comes to investing, if you don't have an exit strategy, then you really have no strategy at all. And with no strategy, you'll never make any serious money in the markets because you'll always be giving back your gains!
The Reward-to-Risk Ratio...
With any investment, you need to estimate your potential reward vs. potential risk before you buy. And if you don't use a stop, that means you have 100% at risk. It is unfortunate that most people don't think about their reward-to-risk ratio like this when they trade. But they should.
Whenever you buy a stock, if you believe your upside potential is about 45%, then use a 15% trailing stop. If your upside is about 30%, then use a 10% trailing stop. It's pretty simple, and it will keep you at a 3-to-1 reward-to-risk ratio. And if you go back and check all of your current investments with the reward-to-risk ratio in mind, you'll probably be amazed to find that in many of these investments, you're risking 100% for a measly 15% expected return - which is no way to make any money!
These are all rough rules of thumb. The goal is to get you to sell when you should, instead of holding and hoping. But the real goal is to give you a defined exit strategy. That way, you'll know when to get out systematically, instead of by the seat of your pants.
If you never know when you'll get out of a stock, then you really don't have a plan. And without a plan, you'll never be able to outperform as in investor!
* * * * *
There are only TWO reasons to ever sell an investment: 1) If the reason you originally invested is no longer there; or 2) If you've hit your pre-defined "point of maximum pain." Both concepts are simple, but most people don't follow either one!
Your reason for being there is gone...
If you bought a biotech stock because its wonder drug was going to be approved by the FDA, but it wasn't approved, then it's time to sell. If you bought because you liked the CEO, and he left, then it's time to sell. If you bought for no reason other than because it was super cheap, and now it's really expensive, then what are you doing still holding it?
Why did you buy? There is nearly always a MAIN reason why you got into an investment. Go back and remember what it was... and then ask yourself if it is still there. Chances are, you'll be surprised to find how many investments you're still holding that you really shouldn't be, by this rule.
Your point of maximum pain...
The biggest killer to any portfolio is a "catastrophic loss." If a stock falls 90%, it has to rise by 900% just to get you back to where you were. So you never want to find yourself in that position, and the best rule of thumb to prevent such a debacle from happening is to use a trailing stop with every stock you own.
I like to use a 20% trailing stop with most stocks although you can be selective and vary the percentage depending on the volatility of the given stock issue. But in every case, the concept of a "stop" is simple. If a stock you own falls by 20%, you get out, and "stop" your pain. The concept of a "trailing stop" is also simple: As the stock rises in price, you raise your "stop" point. If you bought a stock at $5, and it goes to $10, then your new stop is $8.00. And if it rises to $20 without falling by 20%, then your new stop is $16.
When it comes to investing, if you don't have an exit strategy, then you really have no strategy at all. And with no strategy, you'll never make any serious money in the markets because you'll always be giving back your gains!
The Reward-to-Risk Ratio...
With any investment, you need to estimate your potential reward vs. potential risk before you buy. And if you don't use a stop, that means you have 100% at risk. It is unfortunate that most people don't think about their reward-to-risk ratio like this when they trade. But they should.
Whenever you buy a stock, if you believe your upside potential is about 45%, then use a 15% trailing stop. If your upside is about 30%, then use a 10% trailing stop. It's pretty simple, and it will keep you at a 3-to-1 reward-to-risk ratio. And if you go back and check all of your current investments with the reward-to-risk ratio in mind, you'll probably be amazed to find that in many of these investments, you're risking 100% for a measly 15% expected return - which is no way to make any money!
These are all rough rules of thumb. The goal is to get you to sell when you should, instead of holding and hoping. But the real goal is to give you a defined exit strategy. That way, you'll know when to get out systematically, instead of by the seat of your pants.
If you never know when you'll get out of a stock, then you really don't have a plan. And without a plan, you'll never be able to outperform as in investor!
* * * * *
posted by Bob Moser at
7:58 PM
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