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Thursday, September 23, 2010

The Sensex is at 20000 – I know I should sell, but what should I sell?

Many small investors may be facing this dilemma, now that the Sensex has touched 20000 and started to retrace a bit. They know in their guts that it is a good time to sell, but are not sure what to sell and how much to sell.

In last Tuesday’s post, I tried to segment the small investor population and offered guidelines on what each category of investors should consider doing. But I wasn’t specific about the selling process.

Selling is a very individual activity, and there can’t be a one size that fits all. At the same time, there are a few situations that call for selling regardless of the age, risk tolerance and financial goals of investors.

A lot of small investors do due diligence and pick a fundamentally strong stock, which they buy at a reasonable price. But they don’t have a plan about how and when to sell the stock. Some sell too soon and make meagre profits. Others hang on too long and lose all their profits.

Selling at the right time and at the right price is a much tougher task than buying. It is a skill that needs to be honed with practice and discipline. A few simple tricks-of-the trade can be combined to take some of the guesswork out of the selling process.

Every time one buys a stock, it should be with a very clear purpose. If it is meant for the long-term core portfolio, then don’t turn it into a short-term trading play. In case the price moves up too far, too fast – book partial profits and hold on to the rest. If it is meant for the short-term trading portfolio, don’t become a long-term investor in it by default because the trade has turned against you.

Use a stop-loss. A wider one (15-30%) for the long-term portfolio stocks and a tighter one (5-8%) for the short-term trading portfolio. If the stock prices move up, use a trailing stop-loss; i.e. move up the stop-loss by the same percentage as the rise in the stock’s price.

If the stop-loss is hit, don’t lower the stop-loss or wait for things to improve. Sell and get out. For heaven’s sake, don’t average down. You may lose some money if the stock starts to move back up again, but you will never get stuck with a huge loss. You can always get back in at a higher price and cover your loss.

Have an asset allocation plan in place. When the Sensex nears its 52 week high, chances are that your asset allocation needs to be tweaked. Use your allocation formula to decide how much to sell. If your allocation to equity has risen from 60% to 70%, you have the option to sell the entire 10% in one lot, or keep taking 2.5% off the table in smaller lots.

What to sell? For reallocation, sell equal percentages from all the stocks in the portfolio. In other words, if you have 100 ITC shares and 200 Tata Steel, and want to sell 5% of the equity portfolio, sell 5 ITC shares and 10 Tata Steel shares.

A mistake many small investors make is they tend to sell the shares that are in profit and hang on to the shares in loss. If a stock is in loss when the Sensex is near an all-time high, chances of its providing any returns in the foreseeable future is nil. Better use the price uptick to sell all of it.

If you are one of those unfortunate investors who entered the market in Dec ‘07 and you are stuck with stocks that are near your ‘buy’ price, don’t sell in a panic because you are getting back your ‘cost’. You are not. You have lost three years of interest. Decide if it is a fundamentally good stock to hold for the long-term. If it is, keep a trailing stop-loss and hold on; if it isn’t, sell.

1 comment:

Eswar Santhosh said...

After witnessing one full cycle of a bull market & a bear market, I now have a fair idea of how my mood swings cloud my judgment. I am, at least in my opinion, attempting not to make the same mistakes of the last bull market. The next bear market should hopefully see me more ready :)

The more years I spend, the more my definition of "long term" expands. I used to think 3 months was long enough, until a 2006 crash made me think of 2-3 years as long and then it expanded to 4-5 years by the end of the last bull run. Now, I think it does not even make sense to think about bull and bear phases. All that matters is the valuation one enters into and manages to exit at (at least partially). I am a very slow learner, I guess :)

Just to give a few examples, some stocks like Dabur, Marico, M & M, Opto Circuits have been good enough for me across all three cycles. Reliance group fared well last time, not this time. On the other hand a few stocks fared no better even at the peak of the last bull run, but have given good returns in this bull run.

In short, the more time I spend in the markets, the more I think that Sensex level should not be the barometer of one's investment decisions. Of course, any irrationality on either side brings the stock prices to extremes, which can be used. But other than that, what's so "holy" about 20K? If the market does not stop and races to 23K, 23K will become the new "20K" :)