Questioning Cramer on Taking Profits

I'm not sure how you all feel about watching Jim Cramer's Mad Money, but I listened to a brief portion today where he discussed taking profits. His comments in brief:

1. When you have solid profits, lock them in.
2. When your portfolio has shot up, you are likely unbalanced.

Totally agree with #2, but I've always had a different take on taking profits. On my core long positions, my general principle is to wait until fundamentals start to take a turn and then liquidate the entire position after the stock is down 15-20% from its peak. This assumes I've made good money on my investment.

Am I crazy?

The smartest mentor I ever had taught me that it's better to lose the top 20% of a stock price than to give up 50% of the upside by selling too early.

By too early I mean that stock prices can decouple from fundamentals. I hold onto the belief that I don't tell the market what something is worth; the market tells me... and, out of respect for the market, I let it tell me what fundamentals translate into as far as stock value goes. Stock prices can go a lot higher than people expect, even if the underlying fundamentals do not support it. So even though fundamentals may change, I am still willing to wait and capture additional upside.

It's a balance of "letting our winners run" versus selling at fair value. Trading around a stock is a great strategy if one has the correct price target and can stomach the fees. But...On behalf of those of us who are not successful trade timers (or who cannot afford it), trading around a stock can often be a wash net of fees.

The psychology of trading around a stock and locking in profits is tempting. But over time, I've also learned better things can come to those who wait, Mr. Cramer.

Comments

[Eck]

Great perspective, Jaimi!

"The smartest mentor I ever had taught me that it's better to lose the top 20% of a stock price than to give up 50% of the upside by selling too early."

I watch Cramer religiously, but have learned to take his advice with a grain of salt. In retrospect, I would have done better with most trades over the years, had I been more patient with both my buy and sell orders.

[Tremaine]

I thought that one of his "rules" is to sell gradually as stock moves up and you have made a significant profit. I have heard him say that it is often better to "play with the house's money", so to speak.

Also, I'm not sure waiting for fundamentals to "take a turn" is necessarily good when you are in a cyclical stock when the economy or the specific sector shifts. Good fundamentals don't always matter when the institutions shift out all their money to another sector.

[mejnoon]

While I love to sell as the market or a stock rises, my problem has
always been that I have not sold enough stock to make a dent with
my profits. The moral is, if you have only sold some shares as the
price increases, you had better sell a lot more or all of your position
quickly, when the price begins to decline. Waiting for the next
upturn will inevitably make you a loser, especially if on margin.

[CharlesLloyd]

One way to take gains on a stock which has moved up is to sell calls against the stock. If you sell at or slightly in the money, you get some downside protection and a bit of time value in case the stock continues up. If it goes down, you have a bit more cushion before you decide to sell. If it goes up, you can roll the short calls up and out several months for a small credit. I like to keep my short calls about 1 strike ITM for better downside protection. Sometimes I sacrifice a bit of upside, but at least I'm still in the game as compared to simply liquidating my stocks.

[JaimiGoodfriend]

Thank you so much for all of your insightful comments! I am actually in Charles' camp and sell calls against winners as a way of taking small profits if there is some near-term volatility on the underlying security.

Tremaine, you raise a great point...good companies do not always make for good stocks. I do have separate thoughts about that and...great idea to publish another article! Coming soon...

...To your point, well taken. We must look at fundamental shifts in macro environments to anticipate fundamental changes in specific companies. We can't just wait for things to happen to firms in real-time in order to act.