To take profit or not? That’s the question

Simon Brown, founder and director of JustOneLap.com.
Simon Brown, founder and director of JustOneLap.com.

As global and local markets continue to rally after the collapse of late March and early April, I am being flooded with questions from people who bought shares during the collapse and now want to know if they should be selling.

The point I always make is that an investor or trader needs to have a plan for selling a position when they initially enter that position. Sure, the plan is to make a profit, but it needs more detail because what is a profit? Is it 1% or 100% or somewhere in-between?

Equally important is that while we focus on the profit side of the equation, we also need to be very cognisant of the potential for a loss and, as such, our exit plan needs to have both a profit and a loss side.

For traders, the loss side of the exit plan is easy. You have a stop-loss that is a pre-determined level at which you exit the trade, no questions asked. You’re losing money and you need to stop the bleeding and protect capital.

The profit side of the trade is harder. Some charting patterns give potential targets for exiting at a profit, while other traders will use different technical features to determine when the trend is going against them. Still others will take their profit once they hit a certain profit point.

Personally, as a trend trader who accepts that trends can last longer than expected, I usually exit trend trades on stop-losses that I trail upwards as the trade moves in my favour. It does mean I give up some of the profits as the trade reverses and hits my stop-loss. But it also means if the trend continues longer than expected, I can bank more profits.

The point is that no exit strategy is perfect, but we need to live within that imperfection and always have an exit plan in place before entering a trade. And we must always action the exit as per the plan and not change our rules halfway through the trade.

Long-term investors still need an exit strategy, but it will likely be based on fundamentals rather than price, as it is with traders.

As I have written before, when buying a long-term holding, I have my list of what I really like about a company. That includes at least three points that set the company apart from its peers and make it my preferred purchase. I then hold and bank the dividends.

Ideally,I’ll try to hold them forever if the fundamentals remain in place. This point is important. I’ll only exit when one or more of the points I liked about the company starts to erode.

So, for example, I may buy a retailer because I like their operating margin and so I would keep a close eye on that. I would not worry about the operating margins of the company’s peers and rather be focused on the operating margin of the company in which I have invested.

The issue here is that it’s very unlikely that I’ll ever be a seller anywhere near the top of the price action. But that’s fine. I don’t want to be a panicked seller. Rather, I want to hold for as long as possible and, if things go well, I’ll potentially be sitting on hundreds of percent of profit. So, losing some of that profit before exiting is far from the end of the world.

The bottom line is that you must understand that there is no perfect exit strategy and to accept that fact. You need to be clear about your exit strategy when you enter the position. Otherwise, you’ll panic as the position moves in your favour or against you and end up hurting your overall profits.

This article originally appeared in the 21 May edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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