How To Lock In Your Single-Stock Gains Before It’s Too Late

How To Lock In Your Single-Stock Gains Before It’s Too Late
Carl Hazeley

about 3 years ago3 mins

What’s going on?

Between earnings season and the r/WallStreetBets saga, recent weeks have shone a spotlight on the risky business of investing in single stocks. One question that’s come up time and again in the Finimize Community is, “When should I sell?” And while there are several ways to skin that particular cat, the two approaches outlined below should help guide you to an answer.

Prepare for a wild ride if you don’t have an exit strategy (Source: Stock Trader's Almanac)
Prepare for a wild ride if you don’t have an exit strategy (Source: Stock Trader's Almanac)

What does this mean?

Fundamental analysis

If you’ve bought into a stock, you’ve hopefully done enough research to be satisfied that it’ll at least maintain, if not increase, its value over time. You might have forecasted how much money the company will earn in the future – and therefore worked out how much its shares should end up being worth.

Analysts call that figure a price target. Ideally, an investor who’d bought shares on this basis would keep them until the price target was hit. You’d then look to sell them on and invest the resulting cash in more attractive opportunities.

But sometimes the right time to sell is before a stock hits your price target. A company might, for example, fall short of your earnings expectations, leaving it less likely to achieve the price target you had in mind in the time period you’d planned. Or sentiment could shift against you: investors might fall out of love with growth stocks, for instance.

Whenever you raise or lower your price target, it’s helpful to ask yourself this question: would I buy these shares (again) today, knowing everything I know about the company now? You should almost always be able to answer “yes” – since that’s effectively what you’re doing on every day you don’t sell. If the answer’s no, then it’s probably time to cash in your chips and put that money to work elsewhere.

Managing your position

Of course, you might’ve bought into a stock without a specific price target in mind. If that’s the case, don’t sweat it – there are other techniques that can help you figure out both when and how much to sell.

A tried-and-true method involves simply selling half your stake in a stock once it doubles. That lets you take your initial investment off the table while remaining well able to benefit from any further increases. Of course, share prices doubling isn’t exactly an everyday occurrence, even if it’s not unheard of with smaller stocks.

A more conservative approach would be to sell 20% of your position in a stock after it rises 40%, then sell 20% of what’s left after it goes up another 40%, and so on. After two turns you’ll have taken around 60% of your initial investment off the table – but will still have a stake 25% larger than you started off with. The idea’s to keep hold of your winning investments as long as possible while mitigating your risk.

Nevertheless, as the chart below shows, even a 40% gain’s something you’d hope to see a stock deliver over a matter of years rather than months or days. (Note also that this technique employed a “stop-loss” that triggered a total sale upon the investment falling 20% from its last peak.)

Managing your position in practice (Source: Jeffrey A. Hirsch and Stock Trader's Almanac)
Managing your position in practice (Source: Jeffrey A. Hirsch and Stock Trader's Almanac)

Why should I care?

Aside from this being a question on many Finimizers’ lips right now, if you’re going to invest in or trade a portfolio of stocks then you’ll hopefully find these suggestions simple and useful to follow.

Tools and techniques like these are important because buying stocks is arguably the easy bit of investing: it’s much tougher to diligently manage your portfolio and sell when you probably should – and harder still to do so dispassionately.

Rather than admit their mistake, most people are psychologically programmed to buy more of a stock that’s fallen in price, arguing that makes it more of a bargain. Similarly, most people lock in profits too soon.

One of the secrets to a properly performing portfolio is going against these natural instincts and putting in place processes – even if only a couple – that can protect and reward you no matter where you are on your investing journey.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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