As the stock market indices touch new highs every day, those investors who have missed the rally are entering the market which further boost the indices. But, in order to realise profit one should sell the shares at the right point of time, which is an important part of investment science. So, when you should book profit? Is it when the valuation of your shares is high; market is volatile, prices have reached lifetime highs and lost steam or should you wait until your targeted rate of return is achieved or should you hold the shares for the long term?
Reduction of risk
As stock markets are more volatile compared to the past, it is essential to book profits at regular intervals. Some investors stay put in certain specific shares without any fear as they think that market volatility is only short term and it may not affect their holding, which may be true to some extent. On the contrary, smart investors make use of the opportunity to book profits and maximise their gains.
For instance, Mr A bought shares in ABC company at an average price of Rs 840 and sold at Rs 905 and thus booked a profit of Rs 65 per share. Again, he bought back the same company’s shares at Rs 846 with a target price of Rs 905. If he had considered himself as a long-term investor and would not have booked profits, then opportunity lost was Rs 59 (905-846) per share. If you book profits at regular intervals then you can hedge the risk.
No love and affection for shares
Often, investors fall in love with their shares so that they don’t want to sell. The appreciation of shares, if the investor does not book profits at appropriate time, is like the appreciation of investment in immovable assets like real estate. Financial assets, especially shares, are very easy to enter and exit. You can always buy the shares at lower levels after exiting at the right price.
Lifetime high price
When indices are touching lifetime highs with some share prices hitting the roof and still climbing up each day, you should stop chasing the market and wait for the correction. Avoid booking profits because you may get the feeling of being left out. Don’t invest further but sit tight on good shares and wait for the correction. Increase your cash balance to utilise a market correction in the future. Enhancing your cash balance can act as a hedge to take advantage of the movement of the market in either side. If the market goes up, you are staying invested and if there is a correction, you have the cash to buy shares at cheap rate.
Practice of average out
One of the most common strategies adopted by investors is to average out when the share price drops. It may not be a good strategy as it is difficult to identify what is the bottom price of the share that you are averaging out. In such a scenario, one should trigger stop loss to book profits or protect profits. One should go for average out only when the stock price is increasing or the stock retreating from its bottom. It is always better to book profits when the stock is in bearish mode.
The movement of the stock market indices is never linear. Accordingly, investors should buy at the interim dips and sell the same during rallies. But this does not mean that you should sell your entire portfolio then buy it back. If you book profits at regular intervals, you can increase your returns manifold.
The writer is associate professor of finance & accounting, IIM Shillong