It is never wrong to take a profit is one of the ancient rules of stock market investment. Yes, the share price may go on zooming up still further, but your profit is safe. One alternative when winning is to hedge your bets by selling part of the holding to recover the original investment plus a bit of profit, and let the rest ride just in case there is further growth left. Another of the hallowed sayings of the market comes to much the same thing: ‘Leave some profit for the other chap.’ This is deeply reassuring stuff, and it eases the irritation of selling when the share continues to rise – but just consider the odds against being able to buy at the bottom and sell at the top.
By some curious chance most of the advice from professionals is about how to secure your profit. The assumption is that nobody ever buys a dud. There is less helpful advice about when to join the other sleek rats heading for the shore.
In falling markets private shareholders fall into two opposing camps. There is the one Naipaul described, who hangs on to the most obvious rubbish in the hope it will eventually recover. Then there is the sort who panic at any serious drop and bail out in the expectation that once the price is heading downwards, the law of gravity will continue to operate. Both are probably wrong.
The point about private investment is that it is generally for the longish term, so the buyer should have done some pretty careful research on the business before buying its shares. The corollary is that if it continues to meet those criteria (good management, reasonable margins, innovation, good financial control, etc), then it may well be a good idea to hang on and just go on collecting dividends. On the other hand, that also means the investor must continue with the work, to see if the company is still up to snuff and therefore worth backing. If not, sell.
So much for cashing in profits or preventing further haemorrhage for a failure; that assumes the market as a whole is still healthy. The problem is spotting when the market is sick and likely to get worse, and knowing whether it is a blip or the market on the turn.
For instance, there is the time when a roaring bull market suddenly falters. This could be the result of some external trigger like a trade war or an apparently unconnected event – why the hurricane that roared across southern England in October 1987 should have triggered a plunge in prices still leaves market analysts baffled. Another cause can be a general loss of impetus. In some curious and indefinable way the enthusiasm that had buoyed up everybody and had seemed ready to continue for ever suddenly drains away. Nothing seems really satisfying. Even good news fails to lift prices, though unhappy news knocks them back. These are signals of a market on the turn and indicate that it is time to start selling before the rout starts.
Once the bear market is truly under way, selling on the way down is trickier. Professional investors are ruthless about getting out if the signs look bad, and many institutions now have computer programs that automatically start selling when a certain percentage decline has been noted. This is one of the reasons the New York stock exchanges can sometimes register accelerating falls in a share or even the market as a whole, as computers are automatically triggered to save what can be salvaged. Private shareholders, however, are always slow to sell. It is reckoned to be a mixture of ignorance (they have not been following the share’s performance), sentimental attachment to a carefully chosen share, and a sort of inertia that suggests hanging on for just another day or so in case it bounces back.
The judgement is between cutting your losses and not missing out on a recovery. There are some warning signals that may suggest a discreet exit; for instance, there could be conflicting indicators and rumours about the company whose shares you hold. Another good test is to ask yourself whether the shares have become so low and the indications of good profits so convincing that the shares seem an irresistible bargain – if not, it is probably a good idea to sell. Even if you are convinced the market has got it wrong and the business will bounce back, it can be shrewd to sell. Then, if the price continues to fall and the indications are coming through that the company has turned the corner, you can always get back in.
Source: Becket Michael (2014), How the Stock Market Works: A Beginner’s Guide to Investment, Kogan Page; Fifth edition.