Some Practical Advice On When (And How) To Book A Profit…

One of my favorite movies is the classic 80s film Trading Places. Starring Dan Aykroyd and Eddie Murphy, it tells the story of a young commodities trader (Aykroyd) who is unknowingly subjected to a bet where he must trade places with a streetwise hustler (Murphy) in a cruel social experiment.

If you haven’t seen it, I highly recommend it. One line sticks out to me from the film, in which Aykroyd’s character laments how rapidly fortunes can turn.

“You make no friends in the pits and you take no prisoners. One minute you’re up half a million in soybeans, and the next, boom, your kids don’t go to college and they’ve repossessed your Bentley.”

This sentiment may be true when you’re dealing with derivatives contracts on commodities. But it also hits home for those of us who are focused on stocks, too.

In this market, it only takes a couple of bad days to unravel a winning trade and turn a potential big gainer into a painful loss. But selling too early can also be frustrating if the stock (or options trade) continues to climb.

And if that weren’t enough, there are the times when you like a stock but don’t pull the trigger – only to watch it skyrocket. All you’re left with is woulda-coulda-shouldas.

A Classic Example

Case in point, when I started scouting candidates for Takeover Trader when we launched the service back in March 2020, I had my eye on Shopify (NYSE: SHOP).

As you may know, SHOP is a top provider of e-commerce software. It was your classic case of a “hot stock”. At the time, the stock was trading in the $350 range. Less than three months later, it was within shouting distance of $800 per share.

At that price, SHOP was trading at roughly 1,500 times its projected annual earnings of $0.50 per share. The price tags on some teleconferencing and cloud computing stocks were equally steep.

As a value investor at heart, it’s not easy for me to pull the trigger on stocks trading at such nosebleed valuations. But it’s important to remember that growth is a component of value. After all, the intrinsic value of any business is a function of its future cash flows discounted back into today’s dollars.

All things equal, a company growing the bottom line at 30% to 40% annually should rightfully command a richer multiple than slower-moving rivals. As Warren Buffet says, growth and value are joined at the hip.

I should note SHOP underwent a 10-for-1 split in June this year. And when we entered a bear market earlier this year, formerly high-flying tech stocks like SHOP got hit hard. Now, the stock is worth less than it was before the pandemic.

I wish I would’ve taken the plunge with SHOP back then. And I’d love to tell you that I would have had the foresight to get out at the very top. But of course, hindsight is 20/20.

I haven’t let that stop me from finding other big gains. But in this market, I’m not hesitating to book a profit — especially if we find ourselves on a significant gain in a relatively short period of time.

Do I hate to miss out on those extra gains? You bet. Nobody likes to leave potential gains on the table. But overstaying your welcome and possibly walking away empty-handed isn’t any better. As they say, nobody went broke taking a profit.

Here Are Some Steps I Take

Rather than leave you with that, though, I want to offer some practical advice.

In many cases, a holding can reach your target price (something you should always have in mind) and continue to move higher. After all, stocks can get over-extended to the upside just as they do to the downside.

So instead of selling outright, sometimes I like to use a 10% or 15% trailing stop loss. This tactic lets me stay on board the rally, but automatically exit whenever the security retreats a predetermined percentage from its peak.

Sometimes, I also like to split the difference. By that I mean cashing out profits on part of my position while letting the rest ride.

Ultimately, the timing of any buys/sells is your decision. Everyone has their own unique investment objectives and risk tolerance. But the main thing I want you to take way from this is that you shouldn’t get too greedy — especially in the middle of a challenging market where gains are hard to come by.

Sure, things will inevitably turn around. But in the meantime, you should exercise caution and harvest profits where you can.

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