Therefore, it is often a mistake for investors to take profits early

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• Selling in the midst of the bull market makes little sense

• Investment alternatives should be evaluated prior to sale

• Shareholders don’t die from profit-taking, but good investments do

One of the most well-known and always applicable stock market wisdom says: “No one has ever died from taking profits”. This proverb is intended to remind investors that only the realized price gain is an actual gain.

“The trend is your friend”

In practice, however, it often does not always make sense to collect book profits early on. Because the mere fact that the capital market has been doing well for several weeks, months or maybe years does not mean that a crash or a correction is bound to happen in the foreseeable future.

Historically, there have always been bull markets on the stock market for a very long time, while the bear markets usually took place within much shorter periods of time. As a result, it can often be very disadvantageous to take profits when the market is generally bullish and company data does not provide a reasonable reason for stock prices to fall.

With the saying: “The trend is your friend”, another stock market wisdom comes into play in this context, which states that it is statistically much more likely that an existing stock market trend will last longer and not necessarily end abruptly. Consequently, it is not advisable for investors to trade against the prevailing trend. The fine art of the stock market is to let profits run until the prevailing upward trend reverses.

Equivalent to this adage, the stock market adage, “Never catch a falling knife,” says that investors should never blindly buy into a bear market. Investors must therefore know exactly what phase the market is in and what trend is currently prevailing on the stock exchange before buying or selling any security.

Investment alternatives must be planned in advance

Selling stocks just because they’ve been up for a few days and weeks doesn’t really make sense without further thought. Such a sale usually only makes sense if there are better investment alternatives or options that promise a better risk/reward ratio.

Instead of hastily converting book profits into real profits, investors should therefore plan ahead exactly which new investment can be made with the realized profit plus seed capital. “Investors cannot help but regularly decide anew whether, in their opinion, a share is worth what it is being asked for on the stock exchange. Or whether – despite a good run – they should not even buy it,” is the assessment of one Spokesman for the asset manager DWS to the SZ.

The chances of not selling are unlimited

Since the valuations of some technology companies have now reached extreme heights, many experts are advising profit-taking in this area in particular. However, many examples from real stock market events clearly show that not selling also brings great opportunities. Because while the possible loss in the event of non-sale is a maximum of 100 percent, the conceivable profit is almost unlimited.

Although a share can fall from 100 euros to 0 euros at any time and thus give the investor a total loss of 100 percent, it can also rise from 100 euros to 1,000 euros at the same time and give the investor a book profit of 900 percent.

Shares of companies such as Tesla impressively show that apparently exaggerated valuation ratios, i.e. high P/E ratios, PBVs and KCVs, are by no means a reason to sell. For example, Tesla shares were recommended for sale in a row below $200 and still climbed to over $800 in the months that followed. Tesla investors, who got out at around 200 US dollars despite the intact upward trend, have thus missed most of the return opportunity.

In this case, taking a profit was not only wrong, it was a bad mistake. Unfortunately, it is not every day that investors find real top companies whose prices suddenly and steadily go through the roof, such as Amazon, Netflix or Apple.

Over time, such top corporations can not only multiply fivefold, but also fiftyfold. Accordingly, until the beginning of 2013, taking stock splits into account, a Tesla share cost less than 10 US dollars.

Even the professionals often sell too early

A practical example from 1999 shows that hasty profit-taking is the rule rather than the exception, even among Wall Street investment professionals. In 1999, for example, Shirley Lin, who worked for a private equity fund of the major US bank Goldman Sachs, was offered a 50 percent stake in the Chinese e-commerce company Alibaba, which would give her a total of five million US dollars tasted

However, Lin and her colleagues felt that such an investment was too risky at the time. The team therefore decided to invest only three million US dollars. With that $3 million investment worth just over $22 million just five years later, Lin and her team decided to exit the position to realize a return of over 600 percent.

Today, however, this position would not only be worth 22 million US dollars, but a total of more than 200 billion US dollars and thus almost twice the current market capitalization of Goldman Sachs. The historical example impressively shows that extraordinary returns are usually also extraordinary need a lot of time. As a result, investors who sell their position after a 100 percent price gain at the latest will never have a real multibagger in their portfolio.

Part sale as an alternative

However, security-minded investors who want to take their profits from time to time can also consider a partial sale. The partial sale offers the advantage that the investor continues to participate in the respective share price development with a part of his investment, whereby his possible loss, should there be a rapid trend reversal, is limited to a smaller position.

Investors who follow such a strategy reduce their risk directly, but of course also reduce their potential return. “A look at the price lists from 20 years ago shows how regularly DAX companies that have been doing well for a long time can disappear from every list,” the DWS spokesman continued. Accordingly, early profit-taking is not always the worst alternative on the capital market. Fortunately, no shareholders die because of profit-taking, but in the worst case only good investments.

Pierre Bonnet / Editor finanzen.net

This text is for informational purposes only and does not constitute an investment recommendation. finanzen.net GmbH excludes any claims for recourse.

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