When to bank profits?

9th Jan '19 by Rahope0410

15 comments 2908 reads

By way of background I would describe myself as a long term value investor but I like dividends and if I think a company is going places (eg Fevertree) I will diverge from my normal rules. I reinvest all divis.

I have three winners that I’ve held for three years or so - GVC, PPHE and FEVR. I think they will continue to do well. So my question is do I:

a) tuck them in the bottom drawer and watch them hopefully grow.
b) top slice say 20% annually
c) only sell some or all if I’m drawn to something better

There are a lot of posts on stop losses (I don’t use stop losses) but not so much on developing rules for banking profits.

All thoughts welcome!

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About the Author

Rahope0410

Premium Member

15 comments

Montyville2

9th Jan '19

Personally, I try to adopt A, and only consider C if I felt that it was the right time to sell and no other funds were available. I would only sell when you think a company is out of a growth phase. Having said all that the hardest decision is when to sell and most of us have made poor decisions in the past.

Benson212

9th Jan '19

Knowing when to sell is a conundrum for most investors & traders. When I first started investing, I didn’t have sell rules or use stop losses, and I learnt the hard way as to the importance of having concrete sell rules as part of my overall investment strategy. In the absence of sell rules, you will make emotional sell decisions and work off 'gut feel' rather than thorough analysis. As a result, your investments will be horribly inconsistent, as it depends on how you felt ‘in the moment’.

After much research, I found successful investors had sell rules which can be categorised into two segments:
• Defensive Sell Rules
• Offensive Sell Rules

Defensive sell rules are used to keep your losses small and work as a protective profit ‘backstop’. In other words, you need a stop loss to prevent small losses snowballing into larger losses and if you’re at a profit, you need a trailing stop loss.

Offensive sell rules are used to ‘sell into strength’. This comes in the form of profit targets. For example, you might sell 25% of your position when you’re at 50% gain, another 25% at 100% gain and so on…

Ultimately, you need a sell rule for both defensive and offensive situations. Personally, I prefer to use technical analysis for my sell signals because institutions often exit their positions before deteriorating fundamentals become apparent. If you use deteriorating fundamentals as your sell signal, then you are waiting for the profit warning, which may well wipe out your gains and leave you with a modest return for several years exposure in the market.

(LON:G4M) is a perfect example. The technicals deteriorated long before the recent profit warning. This was the warning signal to get out! The defensive profit ‘backstop’ rule would have kicked in long before the profit warning materialised.

However, if you want to go down the value investor route, then all I can suggest is that you sell your investments when they reach fair value (whatever that might be) or sell when the fundamentals change (i.e. sell the profit warning).

My rules are:

Defensive – After purchase, cap all losses between 5% - 8%
Defensive – If the stock gaps down by more than 8%, sell immediately.
Defensive – Once I’m at a 10% gain, move stop loss to breakeven. Apply 10% trailing stop loss from this point onwards.
Defensive – Sell if stock no longer qualifies under Mark Minervini’s stage 2 uptrend criteria.
Defensive – Sell (or tighten stops) when major UK indices have at least five distribution days spanning over four weeks (my warning signal we are entering a market correction).
Defensive – sell weakest stock if I wish to trade a new, high probability setup (weakest stock is my biggest loser in my portfolio).

Offensive – Sell entire investment when it reaches 20% - 25% profit target.
Offensive - If stock is making a parabolic move upwards, sell when MACD histogram makes ‘green to red’ move. (I can explain this if others are interested).

mmarkkj777

9th Jan '19

I agree pretty much with BH1991.

However, one difference is that I never sell a rising stock. I use trailing stops and if I think it has run its course (e.g. for value stocks when it has reached fair value) I close my stops tighter to protect profit. I'm often suprised how much higher they rise than my estimated fair value!! (profit I would have lost). For growth stocks, similar and if you want to invest in them for the longer term you can adopt a wider stop, but it then protects you from major downturns, e.g. like Fevertree had late last year (I got stopped out), or when its phase 2 growth is over.

Not an exact science and the tightness of the stops (or indeed none at all) depends on the approach, whether you are a strategic long term buy and hold investor with no stops (Warren Buffet style) or an investor with trading tactics (Mark Minnervini style) with 7-10% stops.

Personally, I use both styles in different portfolios. Its really horses for courses and I'm sure other people will ave very different views! :-)

Cheers,

Mark.

Rahope0410

10th Jan '19

Thanks for your replies. On a successful stock how do you maintain your trailing stop losses in practice? What tools do you use?

John Cannadine

10th Jan '19

Before taking any action, I would recommend applying the rules discussed / suggested above to the shares in question from when you bought them.

I am pretty sure that you would not have held on to any and therefore not enjoyed the gains that you have.

Make of that what you will - for me hard and fast rules based on % levels don't work.

Personally - unless the shares have broken the long term uptrend (I will let skilled technical analysts let you know whether that is the case) I would not be inclined to sell until they do.

Benson212

10th Jan '19

The simplest trailing stop loss method is to decide upon a fixed % below the current price and move your loss up as it advances. For example, you might decide to implement a flat 10% stop loss. As price advances to 15%, your stop loss is moved up to 5% maintaining the 10% trail. Of course, if price falls your stop loss will not trail back with it.

Using a stop loss will put you way ahead of most market participants when it comes to managing risk, but you could take it one step further by using ATR trailing stop loss or Parabolic SAR. You can plot them on the Stockopedia charts by clicking on the "Overlay" drop down menu and selecting the stop loss indicators. You can find further information on how they work in the Stockopedia chart guide.

As you're a long term investor, you might be better off using a weekly or monthly chart to determine your stop loss placement. The daily chart is best suited for swing traders.

The more advanced trailing stop loss techniques include using moving averages e.g. break of 200DMA /50DMA or break of resistance lines, but I prefer to keep things simple. This makes it easier to follow.

Conduct a retrospective analysis on your trades and see if stop losses have a positive impact on your results. You may find your winners are cut shorter, but on the other hand, you could well have mitigated some of your biggest losing investments.

Benson212

10th Jan '19

I agree with John too. The rules I have listed are more of an illustration as to what sort of rules you can apply. Ultimately, you must decide what rules best suit your strategy and personality. My rules are geared towards trend trading over a 1-6 month time frame. I also time my trades using chart patterns such as Mark Minervini's VCP which means my stop loss rules complement my strategy.

As you're a longer term investor, you need to have much wider stops. As mentioned, it's best to conduct a retro analysis and look to see what works and what doesn't.

smatthews1

10th Jan '19

As a holder of PPH this caught my attention. My original idea behind buying these shares were that the pound had devalued and this should boost tourism. With good exposure of hotels in the UK, I expected this one to benefit.

I use TA a lot when timing my entry's and exits, and although there is nothing inherently wrong with the suggestions regarding technical analysis, I think its foolish to completely ignore the fundamentals. So when I ask my self when is the right time to sell, I have to keep checking the valuation of the company, sit on the fence and forget that I even own the shares. Sounds strange but sometimes after a stock has gone up and you want to bank profits, sometimes they can still offer good value and may even be a buying opportunity. Otherwise is very easy to take a biased view on the company from its share price, and this can really skew your decision making.

In conjunction with checking its valuation I will check back over the last 6-12 months of trading statements and results and make sure there is no glaringly obvious problems or patterns with its results and trading. I will go into a lot of details obviously, sales, gross margins, Debt levels, interest on debt, and most importantly cash flow.

if the stock price has taken a hit due to a market turn-down (which we have seen a lot recently) providing the original investment case stays the same, then I am happy to even top up.

Before I drift on even futher, back to PPH. Trading seems fine, adding more hotels and more renovation as well. Very large debts but these are secured against property so reasonably safe providing they can keep on top of their financing, Management do seem to work hard on keeping this low though.

Book value is very important to me here although it sits at around 2 x market cap. So its fair to say I am getting cold feet at looking for an exit. However on the balance sheet as far as I am aware the property values are taken at a 'book value' and not 'market value', so I remain on the positive side that these valuations could be at a conservative valuation. This quote may support that....

"The Group's gearing ratio based on reported book values (net bank debt as a percentage of equity adjusted for the hedging reserve) increased to 51.1% (as at 31 December 2017: 48.0%). The Group's gearing ratio with the Group's properties at market value amounts to 28.9%

Other positive points for me are, moving to a premium listing which should attract a larger audience of investors, and the share price has held up fairly well during these last few months of volatility i.e no one is really selling.

Overall I would be very interested to hear the thoughts from others on this one.

Sean

mmarkkj777

10th Jan '19

Hi Smathews1,

I didn't mention that I hold a small position in PPH. Which ever way the assets are valued, its a good ratio to market cap. I know the debt is quite high, but with the solid assets (property) I personally don't see this as too much of a problem, I'm looking for a 15-20% uplift on share price during 2019 (I hope that's not famous last words!!!!).

RadioactiveMan

11th Jan '19

The easiest strategy is to ask yourself would I buy this stock today? And if not then it might be time to sell. One caveat I'd add to this is I'd focus on the business case not the valuation as its a recipe for disaster to try and second guess the market.

smatthews1

11th Jan '19

Can I quiz you as to how you arrive at a 20% uplift in share Price. If I work or the NAV I arrive around £510m. Still short of the current market cap.

ISAallowance

11th Jan '19

Hi Rahope0410,

When to sell is really difficult IMO. I have sold shares for 20% profit that have gone on to multibag, and held shares that have doubled and gone on to retreat to 20% up. I have sold shares that have gone down and then they've popped up again, and held shares that have gone down and they've carried on down. Fortunately I've also held shares without selling that have multibagged (and averaged up in some cases), and averaged down on shares where value has outed and they've gone back up.

Just as an example of how hard it is to decide when a rising share has stopped rising, I invite all the technicians on this thread to look at Gamma Communications (LON:GAMA) (which I hold). On a one year chart it looks like an uptrend has halted and a topping process started. On a five year chart it could be argued that the uptrend is still intact.

Based on your original post, I suspect that in common with me you may have a longer average holding period than some posters on the thread (and just to be clear I'm not knocking momentum trading with stops, it's clearly a very valid technique with some very successful adherents.). When I started investing about 4 years ago, I frequently read that most amateurs overtrade, and studies show this loses them money. So I was concerned about overtrading.

Which leads me to the only useful observation that I have, which is that I have found it incredibly useful to track the relative performance of the sell and buy on each occasion that I sell one position in order to buy another. Each year on Stockopedia I start a "Sold" portfolio and a "Replacements" portfolio. Into the sold portfolio I put all the sold positions as buys, with no commissions paid. Into the replacements portfolio I put all the new positions as buys, with the commission from both the buy and the matching sell added. At the end of the year I review the relative performance. Beyond about a year I start again since otherwise new buys become new sells etc and it gets messy.

So far, I happy to report that in both the last 2 years I've been doing this replacements have significantly outperformed sold. In cal year 18 just finished the difference accounted for my entire small (1.74%) gain for the year, I would have been looking at ~5% loss otherwise. So I'm happy that I'm not overtrading, and indeed possibly I'm undertrading.

I recomend everyone with a long enough average holding period tries this sort of feedback on their trading decisions - it is an excellent quality control mechanism. Another benefit I have found is that it helps me to mentally let go of bad decisions - in the previous year 2017 for example I could have mentally beaten myself up about selling Scisys (LON:SSY) shortly before an 80% advance. But as part of the sold portfolio, as a portfolio it underperformed the replacements, even though no single replacement advanced nearly as much.

The final observation I have is that big winners are important - don't let them go cheaply. My best ideas ISA has roughly doubled 2 years contributions in a period of 4 years. When I looked at the gain/loss of all positions, It transpired that I have 21 current positions, I have held 45 positions in total, but absolutely all of the gain (including divs) can be attibuted to the capital gain from only 5 big winners. When you have something good, watch it like a hawk, but don't let it go cheaply!

mmarkkj777

12th Jan '19

Hi Smathews1

I meant I am looking for a 15-20% gain in share price this year (that's my profit target).

Luthrin

12th Jan '19

A topical piece from Bloomberg's Matt Levine:

Investors Have to Sell Stocks Too

Levine's article draws on a research paper published on 2nd January 2019 (freely available to download). Here's the abstract:

"Most research on heuristics and biases in financial decision-making has focused on non-experts, such as retail investors who hold modest portfolios. We use a unique data set to show that financial market experts - institutional investors with portfolios averaging $573 million - exhibit costly, systematic biases. A striking finding emerges: while investors display clear skill in buying, their selling decisions underperform substantially - even relative to strategies involving no skill such as randomly selling existing positions - in terms of both benchmark-adjusted and risk-adjusted returns. We present evidence consistent with limited attention as a key driver of this discrepancy, with investors devoting more attentional resources to buy decisions than sell decisions. When attentional resources are more likely to be equally distributed between prospective purchases and sales, specifically around company earnings announcement days, stocks sold outperform counterfactual strategies similar to buys. We document managers' use of a heuristic that overweights a salient attribute of portfolio assets - past returns - when selling, whereas we do not observe similar heuristic use for buys. Assets with extreme returns are more than 50% more likely to be sold than those that just under- or over-performed. Finally, we document that the use of the heuristic appears to a mistake and is linked empirically with substantial overall underperformance in selling."

WarrantStar

12th Jan '19

I generally buy and hold quality growth shares. I have a range of rules & guidelines to help me decide when to sell. These are designed for two purposes 1) Loss minimisation 2) Profit maximisation. There are plenty of good examples of rules above, but here is another one to consider. If I am fortunate enough to be a long term holder of a share which I consider to be very over valued, then I generally sell all or some of it, especially if it has stopped rising. This is because the likely hood of further price rises is quite small, and the likely hood of price falls is quite large.

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Rahope0410

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