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When Should the First-Time Investor Take Profits?

|Includes: Apple Inc. (AAPL), AIG, APWR

 So we’re going to briefly post about taking profits. Let’s say you’ve bought a stock and it’s gained some decent percentage points, translating into a $200 profit. What should you do?

Selling all of the stocks and pocketing the profit would probably be your first knee jerk reaction, and there’s nothing wrong with that. But what if the stock price goes higher after you sold out? How do you know whether you should sell everything, sell a little, or not sell at all?
The answer lies in how confident you are about the stock. If the price shoots up and you make $200 in a day on no particular news, earnings, or press released by the company, you may want to get out. There are 100 reasons why a stock price spikes with no rhyme or reason – play it safe and keep your distance from these situations when you can. On the flip side, perhaps you’re sure that a stock price jump is warranted (for example, the company releases a great earnings report stating that net income rose 12%); stick with that stock and you’ll likely see it go higher.
Dollar Cost-Averaging is a strategy many use, including us. The basic idea is that you either buy into or sell out of a stock position in small increments. Maybe you want 100 shares of Apple Inc. (NASDAQ:AAPL) but don’t have all the money right now. You can DCA into the stock, maybe buying 20 shares a month for 5 months. The advantage of DCA is that you’ll minimize your exposure in case the stock price drops. The trade off is that you’ll pay commission fees with each order you place, and those add up (100 shares ordered at once would cost $2.95 in commission from OptionsHouse; 5 orders would cost $14.75).

You can also DCA out of a position, and again, the same principles apply. Consider this: we sold our entire position of A-Power Energy Generation Systems (NASDAQ:APWR) after the stock price had moved 25% on us. We figured this was a healthy enought gain, and it was time to take some profits. The plan of course is to get back into the company again when the price deflates. We could have sold them all at once (a cost of $2.95 in commissions), or sold just half of our shares in case the stock price moves up further (a cost of $5.90 in commissions).
We decided the price had moved tremendously and we practice cost-cutting at every turn. So we sold all of our shares, hoping the stock price wouldn’t move and we locked in that one-time commission. 2 days later the stock price moved up another 10%. Had we DCAed, we could have sold half to secure the original gains, and then sold the other half after that 10% move. The gains we would have made would have stumped that measley $2.95 in extra commission. Oops!
Bringing us to our third principle to keep in mind as you consider selling for profits: don’t beat yourself up! Take the emotion out of investing. No one has all the answers and no one can time the markets. Even Warren Buffet, widely accepted as the greatest investor of all time and an absolute financial guru, makes mistakes. Last year he injected 5 billion into American International Group (AIG) preferred stock (preferred stock is a class of warrants that sell at a premium to the common stock price, the price we’re used to. Preferred stocks come with fat dividends – Warren’s dividend in AIG was reported to be 10%). The cash infusion he made, along with government bailouts, likely saved AIG from bankruptcy – but Warren lost a ton of money when AIG’s stock crashed another 40%.
Everyone makes mistakes – we just made one with A-Power. The most we can do is commit ourselves to education, make efforts to operate in our best interests, and learn from the mistakes we’ll inevitably make.

Disclosure: none