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Tuesday, December 29, 2009

Is this a good time to take some profits from the stock market?

A lot of small investors must be asking themselves that question - valuations are no longer that attractive for fresh entry, neither is the market correcting in a major way. So, is this a good time to take some profits home?

The answer depends on what you did, or didn't do over the last two years. If you entered the market during Dec '07 to Feb '08, you are probably not in profit yet. The question of booking profits does not arise.

If you were smart or brave enough to invest during Oct '08 to Apr '09, you must have multiplied your investment 3 or 4 times, and have booked some profits already. If you haven't done so, this may be as good a time as any.

What about those who entered before Oct '07 or those who entered between Mar '09 and Sep '09? You are probably looking at smaller profits and are wondering whether to quit while ahead. 

For more than two months, the stock market has been facing headwinds every time it nears the 17500 mark on the BSE Sensex index. Despite buying by the FIIs, the index has not been able to make a new high.

Technically, there is long-term resistance in the 17500-18000 zone. That could be one of the reasons why the bears are pressing sales near the 17500 mark. Unless the BSE Sensex chart manages to cross the 18000 level convincingly, a new high may not be sustainable.

Like a mountain climber, who can't make it to the top of a peak in one go without resting, a bull rally needs to pause and some times even move down before making a new high. Why is that?

Because once a consensus begins to evolve that markets are richly valued, if not overvalued, investment experts start advising their clients not to make fresh investments and to book partial profits. As a result, volumes diminish and eventually prices tend to correct.

It may not be a deep correction. Even a 15-20% correction, and valuations start to look attractive, if not cheap. Fresh money starts to pour in again and that takes the index to a fresh high. Are we in a similar situation now?

The possibility can't be ruled out. Market prediction is not my forte. This is only an effort at pointing out the greater likelihood of an upcoming event. By taking some profits home, you may miss out on the last 4-5% of this rally. But isn't that better than being caught unawares when a sharp correction comes - which is likely sooner than later?

Don't sell out completely. Book profits partially and re-balance your portfolio. Set appropriate trailing stop-losses to protect your profits in case of a deeper correction.

Your asset allocation should determine whether you should sell 5% of your portfolio or 25%. If the index drops, you'll have some extra cash to reinvest. If it runs up and away, you will lose out on additional profits but will not face a loss.

Related Posts

How to make money when a market is trending sideways
How to reallocate your assets


The Visitor said...

Good post Subhankar.

So, is this a good time to take some profits home? The answer depends on what you did, or didn't do over the last two years.

Your answer covered most categories of people, but what about those who entered between feb-oct '08 and exit during aug-sep '09, awaiting a deep correction, or those who are new entrants to the market? Is it the right time to enter the markets?

Sanjeev Bhatia said...

Dear Subhankar Ji,

Nice post as always. Just wanted to add my two bits. I was doing some reserach recently regarding historical PE valuations for nifty. It might interest you that in 2177 days of trading (1.4.2001 - 24 dec 2009), The nifty PE low and high has been 10.68 & 28.29. Further, current nifty PE is 23.11 as on 29.12.2009. Historically, nifty has traded above 23 for ONLY 81 days out of these 2177 days i.e. only 3.72% days. Strong case for partial booking of profits and sitting on cash. It would just make much more sense to book profits, even if partial, because if market is correcting, most of the stocks will correct or will be under pressure, no matter how good fundamentally or technically. A 20% down move will bring nifty down to 18.4 levels. Again nifty has traded between 18 and 23 band for 841 days i.e. about 39% of times, certainly more comforting. Incidentally, this is also a tad above long term average PE of 17.2. My ideal, however, would be entering ard 15.

Thanks. You are making all of us much better investors.

Sanjeev Bhatia

Subhankar said...

@TV: Thanks for your comments.

If anyone had entered between Feb and Oct '08 and exited during Aug-Sep '09, he may have broken even or made small profits.

Getting out of the market completely in the hope of a deep correction is unwise. Timing the market is not easy. I find it easier to book partial profits, and stay invested as per my asset allocation.

For new entrants, the time to enter is when you have money to spare - after exhausting PF/PPF, PO MIS/Bank FD options that protects the principal.

@Sanjeev: Appreciate your comments and thanks for sharing some interesting facts about the Nifty.

The figures show that taking partial profits and staying invested enables investors to benefit two ways - having some ready cash if the prices fall, and riding profits should the market move up further.

As a general thumb rule, enter when a stock or index P/E is trading below 15 and start to book profits when the P/E crosses 21. Such programmed systems don't always work, but it is better to have a system that works more than 51% of the time, than to leave everything to chance and destiny!

Jasi said...

@Sanjeev, very interesting analysis. Thanks!
@Subhankar sir, I had actually asked a similar ques in one of your posts recently regarding the usage of Nifty PEs for basing investment decisions. For me though the jury is still out :)

Which brings me to a question, what tools do you use to figure out market valuations? Do you also rely on market PE?
Other than a correction, are there other factors that can change market valuations?

Oh and thanks for this interesting post! :)

Subhankar said...

Your query on Nifty P/Es seems to have fallen through the cracks, Jasi. Can't remember on which post you had commented. Getting old and forgetful.

Market valuations change if the earnings improve for the index stocks. Don't bother too much about Sensex or Nifty P/Es, unless you invest in index funds or index futures.

For me, it is all about valuations of individual stocks.

N said...

Having invested in the FTSE in 2009 I started profit taking from November so did reasonably well for the year, although I have missed out on the last few percent gains at the year end. In hindsight I should perhaps not have almost fully withdrawn from the FTSE, as of course a correction may not occur for some time, and entering again at this point is not ideal. Experience being everything, in future I would probably remain partially invested until after a clear downturn demanded total withdrawal. However, in the position I am in now, holding cash and little in the FTSE, what would you suggest? Slowly re-enter in stages, or wait for a clear signal that the bull market is continuing and invest a larger sum, or wait for a correction? My instinct says the first opion, but I would value your opinion.

Subhankar said...

Booking profits too soon is better than hanging on till the bitter end and face losses. I always prefer to be first-in and first-out.

This is where asset allocation becomes important - to decide how much to sell at a time. Selling in small lots during bull markets and buying in small lots during bear markets may work.

If you are investing in the index, there is no harm in putting in a regular sum of money each month - using cost-averaging or value-averaging principles.