Yesterday, the BSE Sensex and NSE Nifty closed 1.22% and 1.26% lower at 24,893.81 and 7,558.80 marking their 15 month and 13 month lows respectively. Many fear that the downside is yet to conclude. Many also quote that this is the right time to enter, but in small quantities. The entire emphasis is on what to buy and when to buy. Indeed, buying at the right price may ultimately determine the profit gained, but SELLING at the right price guarantees the actual profit.
One of the common mistakes investors make is selling the winning scrip too soon and holding the loser infinitely, waiting for an improbable rebound. But, what is "too soon?" is the question to be asked. Well let’s go deeper.
Savvy investors don’t always pick scrips that rise fivefold. It is the timing of their entry or exit from a stock that makes them leaders. They don’t shy away from booking losses. Most investors don’t know when to exit the position. Let’s take an example from Arjuna's son Abhimanyu of Mahabharata. He successfully took on all the Kauravas in the final battle and even entered to the core of the Chakravyuha. He perished because, though he knew how to enter the Chakravyuha, he did not know how to come out.
Applying the same analogy in stock market, say you bought a scrip say Unitech Ltd. at Rs. 13.40 a share on June 2, 2015, hoping to reap profits someday by selling it. But, it falls by 36.50% to Rs. 8.50 the next day and now you a have a serious decision to make. In case you are thinking of a rebound, for your stock to reach the buying price first, it has to make a 57.60% gain as against the 36.50% fall which is difficult. Anything can happen; the bears might continue to rule the stock or it might rebound. So think again.
Let’s say it plunged by 50% to Rs. 6.70 a share. Now, it would take a 100% gain for it to reach atleast the buying price, keep aside your profit ambitions. Do you think it is possible? Well it is possible but would firstly require the bulls to break the control that the bears have over the stock and then take it higher. This would take a hell lot of time in most cases. Wouldn't you rather cut your losses early and free up the money to purchase another stock with better probability of advancing?
So, while booking losses, keep some rules in mind, such as:
- Exit a stock that falls 8% below your purchase price. Follow this regardless of how highly you value the stock.
- The larger the loss, the higher the recovery you need to get back to the break-even level (See the example in the previous paragraph).
- Tax considerations and brokers' commissions should rarely trigger you into your sell decisions.
Now, a lot talked about booking losses. Let’s take a look at the profit booking part which everyone waits for while buying a stock. Earlier we had mentioned about selling a stock “too soon”, here’s a simple explanation. Generally, stocks tend to move up roughly 25% to 30% after rising out of a base. Then they may go through a period of consolidation, when a stock seems to go sideways for a number of weeks. Thus, make sure you sell after you've captured a 25% gain. But, there’s an exception; If a stock races up 20% in one to three weeks out of a proper base, it probably means it has plenty of fuel left and you should hang on to it. It may be your best stock. So do not sell it now. Analyze the market conditions and then make the call or else you will end up selling your winner just to see it rise more. The shorter the trip to the 25% level, the stronger the stock.
Sometimes, it’s the opposite. When you see your share price rising, you don't want to sell. You want to see it rise higher and higher so you keep waiting. Suddenly, the market or the sector crashes and so does your stock. Let us understand this with an example, say you bought Titagarh Wagons for Rs. 597 a share on February 28, 2015 and decided to sell when it reached Rs. 700. What happens next is all too common. The stock hits Rs. 700 on March 4, 2015 and you decide to hold out for some more profit, say Rs. 820. Now, it reaches Rs. 820 on March 9, 2015 and the greed continues and you keep holding. Suddenly it takes a downward turn and reaches Rs. 718 on March 16, 2015 and again you hold with the hope of Rs. 800 which unfortunately never happens and the stock price continues to stumble. As a matter of fact, Titagarh wagons touched Rs. 567 on March 25, 2015.
Hence, an important lesson to be learnt is don't let greed or fear get the better of you or the stock market becomes a dangerous arena to play in. So, while booking profits too, keep some rules in mind:
- Set your expectations right and your stop loss too.
- When an investment is obvious to everybody it is usually time to exit.
- Turn a deaf ear to FREE advice.
- Ride the winners till they actually win.
Remember, stock market investment is a long term activity, so have patience. Also, no one likes losses. They are embarrassing, to put it bluntly. So make sure you CUT those LOSERS and RIDE the WINNERS!