Tuesday, September 22, 2009

Learn the Art of Partial Profit Booking

Before we delve into a discussion about partial profit booking, readers may want to do some ground work. In an earlier article, I had given three reasons why you should sell a stock from your portfolio completely. Prior to that, I had written an article about asset reallocation.

Selling a stock totally from your portfolio may or may not generate profits - because the reasons for selling are to avoid a loss because of faulty stock selection or worsening company fundamentals; or, to generate cash for emergencies.

Your timing of selling may not coincide with a bull period, which means you may need to sell at a loss. It is important to note this point, because as human beings we are 'loss averse'. That means, taking a loss causes a bigger emotional upheaval than making a big profit. But prudence demands that some times you do have to sell at a loss - to avoid a bigger one.

Partial profit booking is a different skill altogether. Here, the reason and timing of selling is totally in the investor's control. When and how much quantity you sell depends on your skill and risk tolerance. The profits you make will depend on it.

Here are a couple of reader comments, that are good examples of why you need to learn the art of partial profit booking:-

1. 'I bought a stock at 37 and saw it go all the way up to 180, but did not sell. It came down, and I finally sold at 120.'

2. 'I bought a stock at 18. When it went up to 44 within 3 months, I sold it all. To my horror, the stock kept going up and hit 150. I have learned that to make big profits, one has to hold the stock for a long time.'

Both situations happened during a bull phase. Both investors made decent profits, but missed out on a much larger profit potential. Let us learn how partial profit booking can help.

Firstly, you need to buy a decent quantity of shares - at least 300 or 500 - of each company. Buying 50 shares or 100 shares won't work very well. Secondly, you need to decide whether a particular stock is going to be part of your core portfolio (80-90% of your total portfolio value) or your satellite or 'mad money' portfolio (10-20% of your total portfolio value).

The core portfolio should comprise fundamentally strong large-cap shares which should be held 'forever'. You should add to this portfolio near bear market bottoms, and book partial profits only near a market top. Otherwise, just sit back and enjoy the dividends and bonus issues, and subscribe to the rights issues. Good large-caps find various ways to reward their stakeholders.

The satellite or 'mad money' portfolio usually contains more risky and relatively unproven mid-caps and small-caps. These shares may shoot up like a rocket in the short-term, and collapse in a heap some time later. This portfolio requires closer monitoring, and partial profit booking is a must during bull phases.

Let us assume you had bought 500 shares at 18. You may have set a target - based on technical analysis or fundamental analysis (or both) - at 40 in 3 years. More than 100% returns in 3 years isn't bad at all. Expecting more than that would be bordering on greed.

To your pleasant surprise, you find the stock shooting up and crossing your target within 6 months. What should you do? Sell 200 @ 50, which recovers your original investment plus the 10% short-term capital gains tax (of 640). The balance 300 shares have become 'free', i.e. there is no holding cost for you.

So, enjoy the bull ride by keeping a 'trailing stop-loss' of say, 10%. That means, at 100 the stop-loss will be 90. If the stock moves to 150, the stop-loss should be 135. Sell the shares as soon as your stop-loss is hit.

If you are lucky enough to hold the entire 500 shares through the bull phase and sell it at the very top, then you will obviously make more money. In reality, picking exact tops and bottoms are next to impossible.

Partial profit booking reduces the risk considerably - first by pulling out your original investment; then, by letting profits ride on the balance quantity to the maximum extent possible. It also ensures that you will not make a loss.

(Note: Partial profit booking works in a bear market also. You 'short sell' when the market is falling, and at each drop you buy back a portion of the amount short sold. This strategy is not recommended for inexperienced investors.)



i am very happy to see my concept in your blog subhankar jee ,may be some more good traders can adopt this policy and and can acquire free shares in their demat. This is my concept from many years "EARN PROFIT OF MINIMUM 20 TO 30% ON YOUR PRINCIPLE AMOUNT AND HOLD REMAINING SHARES IN YOUR DEMAT FOR LONG TERM INVESTMENT"

Eswar Santhosh said...

PPB: Perhaps, the only reason why I still survive in the markets.

In the initial 3-4 years, I made several and severe blunders by following too many people and getting into too many stocks. It's only by 2007, I disciplined myself to stick to a portfolio and started part profit booking. Needless to say, not only have I recovered my capital in the PPB stocks, but also managed to recover all the losses of my past blunders.

To have a decent quantity is highly useful - something I am learning of late. (Only hope it's not toooo late :-))

Subhankar said...

@Rajesh: Thanks for your comment.

Not all stocks are suitable for long-term investment - even if the holding costs become 'free' from partial profit booking. I usually sell 'free' mid and small cap stocks to buy fundamentally strong large caps.

@Eswar: Appreciate your comment.

Recognising your blunders is the first step. Learning from the experience and not repeating them makes you a smarter investor.

It is never too late to learn anything. Respect the market and stay disciplined. The market will pay back many times over.

tax_trp said...

dear sir,
congratulations for such a mindblowing blog. i follow almost the same strategy with certain modifications. what i do is i invest say rupees one lakh in a fundamentally good trading stock, whenever it rises 10%, i sell it and book profit of 10000,i invest profit of 10000 in fundamentally forever kind of shares, then wait for 100% rise and sell half of the shares to make my holding free.
intially trying to wait for 100% is too long and risky i guess. bless me with your comments, thanks,
mansoor panjwani

Subhankar said...

Thanks, Mansoor.

I have shared a strategy that has worked for me. That doesn't mean there aren't other strategies that work as well or better.

Every investor should develop a strategy that suits his/her risk tolerance and comfort levels. If it works, stick to it.

SG Money Mind said...

My approach to each and every stock is, buy and hold with no intention of profit booking. This means, I will sell the stock, if I find I would be better of selling the stock. This doesn't take into consideration whether I already made profit of loss on that particular stock.

But on other stocks, where I find the business and company fundamentals makes sense, I will hold on forever irrespective of whatever the daily quote is.

Subhankar said...

Appreciate your feedback, SGMM.

Not all stocks are suitable for buy and hold. Some can give shorter term appreciation because of prevailing sentiment. These are the ones that form part of my 'mad money' portfolio, where the partial profit booking strategy reduces risk.

But, to each his own. If you are following a system that works for you, it is a good system.

Jasi said...

First up, thanks a tonne for enriching us with your experience and words :) Very useful article!
I have some questions :)
1) Is PPB and Asset-Reallocation (AR) linked?
2) When do you do PPB and when do you do AR?
3) What do you do with the funds you obtain after PPB? Do you buy more equity or go in for FD or other debt instrument?
4) You said you sell all of your stock shud it fall around 10%. When do you consider buying it again? Or you dont look back at the shares once sold?
Once again, its a compliment to your writings that I have come up with so many queries :)

Subhankar said...

Thanks for the kind words, Jasi.

A1. Every thing is linked - because it is your money at stake!
A2. Asset reallocation should be done once or twice a year at most - to avoid over-trading. PPB can be done much more frequently - as and when it makes sense to do so.
A3. Depends on the state of the market. At or near a top, I move it to bank FD. Near an intermediate top, I may stay in cash. Near a bottom, I put it back in the market. This amounts to 'timing the market' - which isn't easy.
A4. The 10% is the trailing stop-loss, and I sell when it is hit. If the stock is from my 'mad money' portfolio, I usually don't look at buying the same stock again. Leave the cash in the bank, and use it to buy strong large-caps at the next market fall (which may happen 6 months or 3 years later).

These are strategies that have worked for me over the years. You should try and evolve your own strategy - depending on your risk tolerance and analysis skills.

Jasi said...

Thanks a lot Subhankar Sir for your enlightening responses. Im sorry my work kept my busy from thanking you all this while.
Having read and re-read this amazing post from you ... I've got some more ques :)

"You should add to this portfolio near bear market bottoms, and book partial profits only near a market top."

1. How do you suggest profit taking technique on core portfolio?
2. Are you saying that at all other times one should be sitting on, may be, large unrealised profits even on core portfolio? Is it not wise to set targets on core p/f and book rest as profits? Say anything in access of may be 15% pa?
4. Market top :) How do you figure it out?

"Firstly, you need to buy a decent quantity of shares "
5. Can you explain the importance of this some more as to why is quantity so important? I'm new to markets so as a rule I don't put in more than Rs 5000 in a company. But that has actually bloated my portfolio considerably :P

6. Now, one of my main queries ... what do you do abt shares that do not reach your target? And when do you act? Like, how much time do you typically keep as a share's holding period in satellite portfolio?
7. What is the usual time horizon for targets you keep for stocks? Is it 3 yrs for all stocks like in this case?

As always, I'm sure I can speak for novices like me out there who can't thank you enough for your sharing of wisdom! Pls keep the good work up Sir!

Subhankar said...

Here are some answers:

A1. Partial profit booking in core portfolio - done only if I have some emergency cash requirement, or if valuations look too stretched.

A2. Core portfolio should be carefully chosen and then occasionally observed and just allowed to grow - through dividends, rights and bonus issues.

A3. No Q3.

A4. Market tops can't be identified exactly - but knowledge of technical indicators help to identify overbought situations close to market tops.

A5. The trick to building wealth is to have fewer stocks but own a larger quantity in each. More dividends, rights and bonus shares. Easier to do partial profit booking when you hold 400 or 1000 shares.

A6 & 7. About 1 year for satellite portfolio stocks and about 3 years for core portfolio stocks is enough time to decide performance.

Appreciate the kind words, Jasi.

Jasi said...

Some? I think you have answered all the questions. And so succinctly which I believe is your hallmark ... being brief yet to the point. Thanks ... I really appreciate it Sir.

1. Profit booking in core portfolio should be the same as satellite? Or do we need to take some other approach?
2. So you are suggesting you are fine sitting on unrealised gains in core, hence may be subjecting all of it to market risk?
3. Yea no ques 3, sorry abt tht :P
4. I'm a bit new to this, but what is "overbought situations"? you may skip this ques if it is a bit too complex for me.
5. I think this is the pick for me of this discussion, a gold nugget :) I mean, its such an important idea n funny how we dont see/realise it.
6n7. So if I were to summarise it ... for satellite, if your shares dont perform within an year, you get rid of them. For core, if they dont perform within 3 yrs you sell them. And for satellite, you sell them whenever they achieve their target, before 1 yr but core I gues you always hold on to.
Whoa! So much learning :) Thank you sooo much Sir!

Subhankar said...

1. Profit booking, like investing, has no formula. It depends on each individual's style and risk tolerance.

If I hold 500 shares of Larsen in my core portfolio, I may sell only 50 or 100. If I hold 500 shares of Dhanalakshmi Bank in my satellite portfolio, I may sell 250.

2. Stock investment itself is subject to market risk - so it depends on your risk tolerance to decide how much of 'unrealised gains' you want to risk.

After 25 years of investing and partial profit booking, my core portfolio has negative holding cost. All of it is 'unrealised gains'. You build wealth by partial profit booking near tops and then buying back more shares near bottoms.

4. Use technical indicators like the slow stochastic (above 80%) and RSI (above 70%) to assess overbought conditions.

5. The minimum threshold for a stock portfolio should be Rs 10 lakhs. If a small investor doesn't have that kind of money, he should stick to fixed income and mutual funds. This is a game of quality and quantity.

6, 7. You've got the gist.

Jasi said...

Thanks once again for your rather prompt replies sir :)

"The minimum threshold for a stock portfolio should be Rs 10 lakhs."
Hmmm, so I'm wondering what according to you should an ideal portfolio look like ... how many stocks and how much investments per stock?
One last thing, if you wish to reveal, how much rate of gain have you managed per annum from your investing, thru these 25 yrs sir :)

Subhankar said...

You can hold about 10-12 stocks, of which 8-9 in core portfolio and 2-3 in satellite portfolio.

It is important to pick your stocks carefully, to eliminate churn and allow time for growth.

Stock market gains over the long run rarely exceed 15%. Some years it is much more. Other years it is less.

Ek Veer said...


I just came across your blog and read this wonderful article. I have a very bad memory for remembering numbers and it is very tough for me even to remember the purchase price some of the times. How do you track your stock for partial profit booking? Can you please enlighten us on the tools you use, practices you follow out of your experience?


Subhankar said...

Thanks for the kind words, Naresh.

I use Excel to keep track of my portfolio - with a separate worksheet for 'stocks/funds bought' and 'stocks/funds sold' for each financial year.

As soon as I buy or sell a stock or fund, I record the date and the rate/amount from the contract note or the fund statement.

A separate worksheet includes my portfolio stocks/funds and their quantities with current price, dividends, rights/bonus/buybacks, TTM P/E, P/BV. This worksheet is updated once a week on Saturdays.

If the P/E is less than 15, or the P/BV is less than 1.5, or P/E x P/BV is less than 22.5, I colour-code the stock for 'adding on dips'. If the P/E x P/BV exceeds 50, I colour-code the stock for 'partial profit booking' on rises.

No rocket science - just a simple record keeping mechanism.