In this ocassional series titled JUST ASK, we invite readers to send in questions on stock investing, and personal finance. We will ask an expert (or experts) to provide answers. Below is a question on when is the best time to sell shares - a common enough question with as many answers as there are investors. It is answered by Ernest Lim, a remisier, and 'observer2', a seasoned investor who posts regularly in NextInsight's forum.
Reader: If I have a modest profit for a stock, what should I do? Which option should I take to maximise my returns?
(a) Sell out all the lots;
(b) Sell out only the profitable lots and keep the initial-capital lots;
(c) Sell out only the initial-capital lots and keep the profit lots; or
(d) Never sell. Only sell when the fundamentals - economy or company fundamentals - deteriorate as Warren Buffet have taught investors.
Ernest Lim, a remisier: Dear reader, before I attempt to reply to your question, it would be good to take a step back to understand the basis for entering a trade or investment i.e. whether it's short or long term, whether it's event driven, whether it was on a technical basis or fundamental basis. Different basis should be dealt with differently.
For example, if our basis is that we want to punt on earnings expectation (i.e. it is event driven with a short term horizon and the shares are bought before a company releases its financial results). We should have a pre-set profit-taking level written down even before entering the trade.
If it hits our target price, then we take profits. If it moves up by a bit (but below our take-profit level) and stays there, we should consider liquidating everything since our basis is a short term trade before results release.
If the price unfortunately goes below our cost price and stays there, we would cut loss.
However, if we invest after going through an in-depth analysis of the company and we have a strong conviction and confidence in our abilities in understanding the company and believing that the market has not fairly valued the company yet, then we can continue to hold our investments till our target price is reached.
Lastly, I would like to point out two things. Firstly, options b and c are based on the premise that the initial capital OR the profit is big enough to sell separately after taking into account broker commissions etc.
Also, the amount left should be significant enough to warrant our constant monitoring of the stock, keeping abreast of the company's developments and comparing it to other attractive investment opportunities etc.
Secondly, for option d, “never sell until company fundamentals or / and economy changes”, I would like to highlight the opportunity cost. If I am a shareholder of Stock A which is a great stock with excellent fundamentals, I may still switch to stock B which may be 5% weaker than Stock A on fundamentals but offers 300% more upside (exaggerated here to illustrate my point).
To view Ernest Lim's latest posting in our forum, click here.
observer2: Dear reader, my view is that none of the four options offers the best solution to maximize returns without taking into consideration other more important factors such as:
1. What were the objectives of buying the stock in the first place? For contra play? Speculation? Long/short-term investment? A great tip?
2. Reasons to sell? For example: Already reached target price; good news already out; follow insider selling; deterioration of business prospects; fear of price dropping tomorrow; sell today with the hope of buying back lower tomorrow;
3. Fundamentals of the stock? Blue chip? Penny stock? High/low growth stock? Undervalued stock?
4. Different stocks have different potential returns over different time spans.
Common sense tells us that the key to maximizing returns is to buy at the lowest and sell at the highest price; and the higher the risk factors, the higher the returns.
However, the realty is that NO ONE KNOWS WHERE THE LOWEST OR THE HIGHEST PRICE IS …… UNTIL HE/SHE HAS MISSED IT. Prices would reach their lowest point when market sentiment or the fear factor has reached its highest level and the vast majority just would not want to buy.
The behaviour of the stock market and also its participants never change throughout the ages.
The majority of market participants always have difficulty in making fat profits or retaining the profits they have made because of the instinctive emotional behaviour of “fear” on seeing danger, and “greed” on seeing easy money for the picking. These people are always a step behind the market movement and the “smart money people”.
In order to move ahead of the herd and improve on one’s performance, an investor would find it a great advantage to understand “behavourial analysis” in addition to “Fundamental Analysis” and “Technical Analysis”; and more importantly have a complete change of mindset so as to detache himself from herd behaviour.
All investments have risks. It is for each individual to learn to manage his risks well, taking into account his risk appetite, resources and knowledge of the businesses that he is investing in.
To view the latest posting of 'observer2'' in our forum, click here.
Recent story: JUST ASK: 'Should my sis convert to the CPF Life Annuity?', 'Are stocks good value when trading below book value?'
