Time To Relish? Profit-booking Allows Investors To Have The Cake And Eat It Too
What is success if you cannot really savour it? Actually, nothing. Similarly, in stock market parlance too, seeing money in your portfolio means nothing unless you have booked your profits and held the money in your hands. Only then can you say that you have enjoyed your success.
Furthermore, while the markets have been on an upswing since the run-up to the elections and the subsequent victory of Narendra Modi, many investors continue to wonder how long will the dream run last. They constantly ask whether to book profits or remain invested in stocks in the hope of higher profits, while also worrying about the loss of profits in case of a market crash.
In this article, we discuss when and how to book profits and strategies to protect profits from becoming losses. The first question that one needs to ask oneself is:
WHEN TO BOOK PROFITS?
Basically, any time is a good time to book profits. Here are some of the common scenarios where you can consider booking your profits.
a. When your target price is reached. Ideally, your exit should be decided even before your entry. Hence, once your target is reached, book your profits. Dont be too greedy.
b. When you require funds to meet some of your needs or goals. If you have invested based on some future goals or even if some emergency need for funds crops up, it would be prudent to encash your profits rather than borrowing funds at high interest rates.
c. When the stock has run up substantially in quick time. Generally, when a stock has risen 30% to 40% in quick time, there is a very good probability that there will be some correction. Book your profits before this happens.
d. The stock has entered the overbought territory. This is identified on charts using trend lines, momentum or volatility indicators, RSI or ROC, etc.
e. The stock has become highly overvalued. There are numerous metrics such as price-to-earnings ratio, price-to-book value, EPS, etc., to check if a share is overvalued.
f. There are better investment opportunities with greater returns potential. Across various asset classes, the risk-return potential keeps on changing. If equities are the flavour today, real estate or gold may be tomorrows darling. Even within equities, todays winners will be tomorrows laggards and vice versa. Spot the next set of winners early on, and book your profits from your current holdings and shift to the next best options.
g. The market is turning bearish. No stock or market can keep on going up on a regular basis. There will be up and down cycles. Book your profits before it is too late.
h. External conditions are worsening. For example, economic slowdown, high inflation, sectoral headwinds industry or company-specific negative news flow, etc. Even the best of stocks cannot hold their own against a negative environment.
i. Deteriorating Internals. The only thing that smart money looks at is the fundamentals of a company, and if there is something grossly erroneous, then make no mistake, the stock is certainly going to fall. Grab your profits and exit.
HOW TO PROTECT AND BOOK YOUR PROFITS?
The best way to protect your profits is to book them. Once you have booked your profits, no amount of ups and downs in the stock markets can take it away from you.
Book Entire Profits
If you are sitting on decent profits and feel that the bull run in the stock is nearing its end, sell your entire holding at one go and enjoy your profits. The only caveat being that if the shares move higher once you have booked your profits, do not be disappointed or lose hope on missing out on higher profits.
Partial Profits
Sometimes you feel that there is more steam left in the upward run of a stock, but at the same time you are afraid of the sudden fall. In such cases, partial profit booking is advisable. It means selling some portion of your portfolio and letting the remaining portion be invested for further upside. What this does is that it help encash some of the profits and protect your portfolio from completely going into losses in case of a fall.
On the other hand, since you have already booked some profit, the acquisition cost of the remaining shares automatically reduces, thus giving you a greater cushion in case of a fall.
For example, if you have bought 100 shares of ABC at Rs. 70, your total investment would be Rs. 7,000. Say after six months, the current share price of ABC is Rs. 100, and you sell 50 shares, you receive Rs. 5,000. So, now you have 50 shares remaining and your initial investment left to be recovered is only Rs. 2,000. Hence, your cost of acquisition comes down from the initial Rs. 70 to Rs. 40 now (2000/50).
Partial Profit Booking Can Be Achieved In The Following Ways:
a) Zero Cost Averaging:
Everybody likes the word free. This strategy helps you achieve just that. The zero cost averaging strategy is useful when a stock has run up 25% to 30% or more. It involves taking out the entire invested capital so that your remaining shares become free.
Sell only as many numbers of shares that recover your initial invested amount. For instance, from the above example you can see that, after the share price has moved to Rs. 100, you should sell 70 shares, so that your entire initial investment amount of Rs. 7,000 is thus recovered.
Now, your cost of acquisition of the remaining 30 shares becomes 0 and even if the price goes down to 0, you are not making a loss and any price greater than 0 is your profit.
b) Alternatively, take out only the profit part of your portfolio and keep the initial invested amount intact. Now, you are back to your initial investment amount, but the profit portion is booked and the cost of acquisition of the remaining shares comes down. From the above example, since your profit is Rs. 3,000, sell 30 shares and stay invested in the remaining 70 shares.
Now, since you have booked a profit of Rs. 3,000, your total initial investment comes down from Rs. 7,000 to Rs. 4,000 for the remaining 70 shares, which works out to an acquisition cost of 4000/70 = Rs. 57.1 per share. This gives more buffer in case of a fall.
c) Scale Out:
To scale out means to get out of a position in increments as price climbs. Keep selling a fixed percentage of shares as the price keeps moving up.
That way, you are always booking some profit at every successive newer high. So, in the above example, you could sell 25 shares when the price moves to Rs. 80, the next 25 when the price moves to Rs. 90, the next at Rs. 100, and the remaining if and when it touches Rs. 110.
Stop Loss
Stop losses are by far the greatest ammunition in your armoury to protect your profits. There are two basic ways by which you can keep a stop loss order.
a) Fixed Stop Loss:
You can set your stop losses at a fixed percentage, say 5% or 10% below the current market price or you can use technical analysis and keep your stop loss a few points below the key support level identified on charts on the basis of moving averages, trend lines, momentum, volatility indicators, etc. In case of a downturn, the stop loss is triggered and your shares are sold.
Your profit is booked, albeit a little below the recent highs, but it is profit nevertheless. The only drawback with setting a fixed stop loss is that you are limiting your profits at your stop loss price even when prices are going up from the current price.
b) Trailing Stop Loss:
This is a much better way of protecting your profits. Here you keep on moving your stop losses trigger higher and higher as the stock price keeps on rising. In other words, you are locking in greater profits as the price of the stock moves to newer highs.
For example, if a stock is trading at Rs. 100 and you have kept your stop loss at Rs. 95 and if the stock goes up to Rs. 105, you move your stop loss to Rs. 100. This way at any given point, even if the stop loss is triggered, you will only lose a few bucks from the earlier high.
Portfolio-Focused Strategies
These are the strategies by which you can book your profits based on your portfolio requirements:
a. Portfolio Rebalancing:
The weightage of your stocks in the portfolio might have changed since the prices of many stocks have risen. So, if you had an initial exposure of 25% to stocks, it might have increased to 50% post the rise. You would obviously want to cut down on the percentage because a very high percentage of your portfolio is exposed to greater risk. Hence, select a comfortable percentage and sell only that much amount to get back your desired weightage.
b. Asset Reallocation:
If you feel that the risk-reward ratio has become highly unfavourable, that is the risk is very high and reward potential is very low, you can sell some part of your high-risk equity portfolio and invest that amount in low-risk debt or fixed income part of your portfolio.
c. Portfolio Sectoral Allocation:
Due to the sudden profit in a stock in your portfolio, the weightage of that stock or that sector in the portfolio may have changed.
For example, if a pharma stock has increased by 50% to 60%, then the weightage of pharma sector in your portfolio becomes very high, thereby increasing the dependence on a single sector and consequently the risk. Book profits by selling some shares of that sector so as to bring it back to your desired allocation level.
d. Portfolio Churning:
Take out some profits from stocks that have run up quite a lot and invest that money in newer stocks, which are still undervalued but have the potential to be the next multibaggers.
Options To The Rescue
Unlike Futures, Options are generally considered as insurance or hedge instruments against the volatility of stocks. Heres a look at how Options can be used to protect your profits:
a. Call Options Substitution:
Sell all your equity holdings and book your profits. Alternatively, buy Call Options of the same stocks at a much lower premium. This way you are booking your profits and still playing for an upside. In case of a fall, you only lose the premium that you had paid to buy the call.
b. Protective Puts:
If you own a sizeable quantity of a stock and are sitting on a profit but dont want to book the profit, it makes sense to buy a Put Option of the same stock at a nominal cost. If the stock keeps on rising, your profits will keep on rising, and you will lose only the minimal amount of the Option premium. However, if the stock price crashes, the erosion of your profits will be offset by the rise in premium of Puts.
c. Collar:
Initiate a collar position. If you own shares, buy a Put Option and sell a Call Option. This way, the cash received by selling the Call is used to buy the Put.
You are not shelling out anything from your pocket to initiate this hedge. So, as long as the stock is going up and stays below the call strike price, you are making a profit. But if it falls, the Put will increase in price, offsetting the portfolio loss.
WHEN NOT TO BOOK PROFITS
a. Dont sell just because you are seeing profits after a long time. There is a reason why the stock may be rising. Try and find out the reason and if there is a positive result of your research, hold on.
b. Alternatively, put yourself in the buyers shoes and ask yourself Are you willing to buy the stock at this price? and if the answer is Yes, dont book your profits yet.
c. Dont book profits just because the share has touched a 52-week high. Usually, shares that form new highs, go on to make higher highs.
d. Get rid of your laggards first and hold on to your winners. Chances are that the laggards are not going to rake in the moolah, while the chances of the winners becoming jackpots are quite high.
e. Dont book profits at the first sign of weakness. It may just be a minor pause before a much bigger rally. Try and find whether the rally is a reversal or a retracement.
f. Consider tax implications, but do not make it the basis of booking your profits. Although the tax angle is important, focus on making big profits and you can always pay a small amount of it as a tax.
Furthermore, while the markets have been on an upswing since the run-up to the elections and the subsequent victory of Narendra Modi, many investors continue to wonder how long will the dream run last. They constantly ask whether to book profits or remain invested in stocks in the hope of higher profits, while also worrying about the loss of profits in case of a market crash.
In this article, we discuss when and how to book profits and strategies to protect profits from becoming losses. The first question that one needs to ask oneself is:
WHEN TO BOOK PROFITS?
Basically, any time is a good time to book profits. Here are some of the common scenarios where you can consider booking your profits.
a. When your target price is reached. Ideally, your exit should be decided even before your entry. Hence, once your target is reached, book your profits. Dont be too greedy.
b. When you require funds to meet some of your needs or goals. If you have invested based on some future goals or even if some emergency need for funds crops up, it would be prudent to encash your profits rather than borrowing funds at high interest rates.
c. When the stock has run up substantially in quick time. Generally, when a stock has risen 30% to 40% in quick time, there is a very good probability that there will be some correction. Book your profits before this happens.
d. The stock has entered the overbought territory. This is identified on charts using trend lines, momentum or volatility indicators, RSI or ROC, etc.
e. The stock has become highly overvalued. There are numerous metrics such as price-to-earnings ratio, price-to-book value, EPS, etc., to check if a share is overvalued.
f. There are better investment opportunities with greater returns potential. Across various asset classes, the risk-return potential keeps on changing. If equities are the flavour today, real estate or gold may be tomorrows darling. Even within equities, todays winners will be tomorrows laggards and vice versa. Spot the next set of winners early on, and book your profits from your current holdings and shift to the next best options.
g. The market is turning bearish. No stock or market can keep on going up on a regular basis. There will be up and down cycles. Book your profits before it is too late.
h. External conditions are worsening. For example, economic slowdown, high inflation, sectoral headwinds industry or company-specific negative news flow, etc. Even the best of stocks cannot hold their own against a negative environment.
i. Deteriorating Internals. The only thing that smart money looks at is the fundamentals of a company, and if there is something grossly erroneous, then make no mistake, the stock is certainly going to fall. Grab your profits and exit.
HOW TO PROTECT AND BOOK YOUR PROFITS?
The best way to protect your profits is to book them. Once you have booked your profits, no amount of ups and downs in the stock markets can take it away from you.
Book Entire Profits
If you are sitting on decent profits and feel that the bull run in the stock is nearing its end, sell your entire holding at one go and enjoy your profits. The only caveat being that if the shares move higher once you have booked your profits, do not be disappointed or lose hope on missing out on higher profits.
Partial Profits
Sometimes you feel that there is more steam left in the upward run of a stock, but at the same time you are afraid of the sudden fall. In such cases, partial profit booking is advisable. It means selling some portion of your portfolio and letting the remaining portion be invested for further upside. What this does is that it help encash some of the profits and protect your portfolio from completely going into losses in case of a fall.
On the other hand, since you have already booked some profit, the acquisition cost of the remaining shares automatically reduces, thus giving you a greater cushion in case of a fall.
For example, if you have bought 100 shares of ABC at Rs. 70, your total investment would be Rs. 7,000. Say after six months, the current share price of ABC is Rs. 100, and you sell 50 shares, you receive Rs. 5,000. So, now you have 50 shares remaining and your initial investment left to be recovered is only Rs. 2,000. Hence, your cost of acquisition comes down from the initial Rs. 70 to Rs. 40 now (2000/50).
Partial Profit Booking Can Be Achieved In The Following Ways:
a) Zero Cost Averaging:
Everybody likes the word free. This strategy helps you achieve just that. The zero cost averaging strategy is useful when a stock has run up 25% to 30% or more. It involves taking out the entire invested capital so that your remaining shares become free.
Sell only as many numbers of shares that recover your initial invested amount. For instance, from the above example you can see that, after the share price has moved to Rs. 100, you should sell 70 shares, so that your entire initial investment amount of Rs. 7,000 is thus recovered.
Now, your cost of acquisition of the remaining 30 shares becomes 0 and even if the price goes down to 0, you are not making a loss and any price greater than 0 is your profit.
b) Alternatively, take out only the profit part of your portfolio and keep the initial invested amount intact. Now, you are back to your initial investment amount, but the profit portion is booked and the cost of acquisition of the remaining shares comes down. From the above example, since your profit is Rs. 3,000, sell 30 shares and stay invested in the remaining 70 shares.
Now, since you have booked a profit of Rs. 3,000, your total initial investment comes down from Rs. 7,000 to Rs. 4,000 for the remaining 70 shares, which works out to an acquisition cost of 4000/70 = Rs. 57.1 per share. This gives more buffer in case of a fall.
c) Scale Out:
To scale out means to get out of a position in increments as price climbs. Keep selling a fixed percentage of shares as the price keeps moving up.
That way, you are always booking some profit at every successive newer high. So, in the above example, you could sell 25 shares when the price moves to Rs. 80, the next 25 when the price moves to Rs. 90, the next at Rs. 100, and the remaining if and when it touches Rs. 110.
Stop Loss
Stop losses are by far the greatest ammunition in your armoury to protect your profits. There are two basic ways by which you can keep a stop loss order.
a) Fixed Stop Loss:
You can set your stop losses at a fixed percentage, say 5% or 10% below the current market price or you can use technical analysis and keep your stop loss a few points below the key support level identified on charts on the basis of moving averages, trend lines, momentum, volatility indicators, etc. In case of a downturn, the stop loss is triggered and your shares are sold.
Your profit is booked, albeit a little below the recent highs, but it is profit nevertheless. The only drawback with setting a fixed stop loss is that you are limiting your profits at your stop loss price even when prices are going up from the current price.
b) Trailing Stop Loss:
This is a much better way of protecting your profits. Here you keep on moving your stop losses trigger higher and higher as the stock price keeps on rising. In other words, you are locking in greater profits as the price of the stock moves to newer highs.
For example, if a stock is trading at Rs. 100 and you have kept your stop loss at Rs. 95 and if the stock goes up to Rs. 105, you move your stop loss to Rs. 100. This way at any given point, even if the stop loss is triggered, you will only lose a few bucks from the earlier high.
Portfolio-Focused Strategies
These are the strategies by which you can book your profits based on your portfolio requirements:
a. Portfolio Rebalancing:
The weightage of your stocks in the portfolio might have changed since the prices of many stocks have risen. So, if you had an initial exposure of 25% to stocks, it might have increased to 50% post the rise. You would obviously want to cut down on the percentage because a very high percentage of your portfolio is exposed to greater risk. Hence, select a comfortable percentage and sell only that much amount to get back your desired weightage.
b. Asset Reallocation:
If you feel that the risk-reward ratio has become highly unfavourable, that is the risk is very high and reward potential is very low, you can sell some part of your high-risk equity portfolio and invest that amount in low-risk debt or fixed income part of your portfolio.
c. Portfolio Sectoral Allocation:
Due to the sudden profit in a stock in your portfolio, the weightage of that stock or that sector in the portfolio may have changed.
For example, if a pharma stock has increased by 50% to 60%, then the weightage of pharma sector in your portfolio becomes very high, thereby increasing the dependence on a single sector and consequently the risk. Book profits by selling some shares of that sector so as to bring it back to your desired allocation level.
d. Portfolio Churning:
Take out some profits from stocks that have run up quite a lot and invest that money in newer stocks, which are still undervalued but have the potential to be the next multibaggers.
Options To The Rescue
Unlike Futures, Options are generally considered as insurance or hedge instruments against the volatility of stocks. Heres a look at how Options can be used to protect your profits:
a. Call Options Substitution:
Sell all your equity holdings and book your profits. Alternatively, buy Call Options of the same stocks at a much lower premium. This way you are booking your profits and still playing for an upside. In case of a fall, you only lose the premium that you had paid to buy the call.
b. Protective Puts:
If you own a sizeable quantity of a stock and are sitting on a profit but dont want to book the profit, it makes sense to buy a Put Option of the same stock at a nominal cost. If the stock keeps on rising, your profits will keep on rising, and you will lose only the minimal amount of the Option premium. However, if the stock price crashes, the erosion of your profits will be offset by the rise in premium of Puts.
c. Collar:
Initiate a collar position. If you own shares, buy a Put Option and sell a Call Option. This way, the cash received by selling the Call is used to buy the Put.
You are not shelling out anything from your pocket to initiate this hedge. So, as long as the stock is going up and stays below the call strike price, you are making a profit. But if it falls, the Put will increase in price, offsetting the portfolio loss.
WHEN NOT TO BOOK PROFITS
a. Dont sell just because you are seeing profits after a long time. There is a reason why the stock may be rising. Try and find out the reason and if there is a positive result of your research, hold on.
b. Alternatively, put yourself in the buyers shoes and ask yourself Are you willing to buy the stock at this price? and if the answer is Yes, dont book your profits yet.
c. Dont book profits just because the share has touched a 52-week high. Usually, shares that form new highs, go on to make higher highs.
d. Get rid of your laggards first and hold on to your winners. Chances are that the laggards are not going to rake in the moolah, while the chances of the winners becoming jackpots are quite high.
e. Dont book profits at the first sign of weakness. It may just be a minor pause before a much bigger rally. Try and find whether the rally is a reversal or a retracement.
f. Consider tax implications, but do not make it the basis of booking your profits. Although the tax angle is important, focus on making big profits and you can always pay a small amount of it as a tax.