When To Take Profits

Taking profits is one of the toughest aspects of investing. In many ways selling a stock is like parting with a friend with whom one has spent time and effort to know and to understand. After all, one never leaves when the relationship is going well and there is still much to give each other.

Similarly, who wants to sell a stock when it is making money? Who's to say the peak has been reached and that there are no more profits to follow? Why abandon a good investment?

In investment parlance, one is seeking to maximize investment returns, and if stock has reached the peak of its earning potential then it should be sold. The idea is elegant and straight forward, but in reality it's difficult to implement.

What after all is a maximized investment return? Is it 5%, 10%, 15% or some other percentage? According to the theory, the return needs to be risk weighted. A riskier investment should return more than one with less risk. Fair enough. But again the question remains: how can one implement this risk adjusted rate of return theory?

For example: BIOD was up 40% twice since I bought it. Most recently it was up 2K, and I did not sell it because I expected more. Now half the profits are gone and I only have 1K left. Do I sell? RIMM is up about 10% since I bought it. It's gone from 46 to slightly over 50. Do I sell?

How can I judge what is a fair price to sell these stocks? Before I answer that question I also have to state that both of these positions were down about the same percentage, 40% for BIOD and 10% for RIMM.

The market has no friends. It's a cold, erratic and often illogical amalgamation of opinions. The market focuses on one thing today and another one tomorrow. Bad news are greeted with price increases and good news with price decreases. In the mist of this madness, how is one to implement this elegant risk adjusted return theory.

Min-Max is my answer! As painful as it is to part with a good friend, profits have to be taken at the max level. For BIOD this would be the $6/share level and for RIMM it would be $55/share level. One of the fundamental rules of trading, one which I have not yet learned, is that before making the trade I should have a stop loss and a profit target. This rule makes sense but implementing it seems to require discipline.

Again, it's a nice theory, but then I would not have held on to NFLX, APPL or GOOD during their meteoric rise. How then to know when to use this stop loss/target profit idea and when to discard it? A small profit sometimes is not better than a small loss if it means giving up bigger profits. In retrospect this is always clear, but peering into the future to see this is what makes it difficult.