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3 Common Portfolio Management Mistakes, And How To Avoid Them.

Jul. 05, 2013 9:08 AM ET
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Thomsett's Blog
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Every investor faces an array of challenges in managing the portfolio. Among these is deciding not only when to buy, but also when to sell. There are two circumstances when this decision is most critical: taking profits and cutting losses.

One of the greatest mistakes in portfolio management is in selling to take profits whenever those profits materialize. There is nothing wrong with taking profits, but realistically not every issue will become profitable. A balancing act helps keep your portfolio in balance.

You need to determine when to sell stocks whose market value has fallen, so that you can avoid further losses. This is just as important as profit taking. Loss-reducing decisions keep your capital robust and working. Imagine a portfolio in which you sell only when stocks become profitable. The end result is that you end up with a portfolio full of issues worth less than they were when you bought them. The attrition of profitable stocks leads to a negative selection process.

To avoid this, it is essential to cut losses. Three suggestions:

1. Match winners and losers. If you are going to take a profit today, also check to see if you have issues that have lost money. If you take both the profit and the loss at the same time, you accomplish two advantages. First, you free up more capital to reinvest in other stocks. Second, the loss offsets the profit and helps keep your tax liability down.

2. Identify both a profit-taking and bail-out price in advance. Before you even buy stock, decide in advance when you will sell. This works in both directions. For example, you might decide to sell one-half of stock if and when the value grows by 75%. In this manner, you take profits on a portion of your holdings while leaving the other half to keep growing. At the same time, you may decide to sell all of a stock if its value falls by 25%. This cuts your losses and frees up capital.

These price points can be programmed in advance with stop orders or trailing stops, types of sell orders worth looking into.

3. When you take a loss, don't dwell on it. Move forward. It is easy to get shy about taking losses. No one enjoys making mistakes, especially when they cost money. But realistically, you are never going to get 100% profits in your portfolio. Learning to accept losses as part of the course of investing is a sign of maturity. Successful investors learn from their mistakes, and do no stay out of the market fearing further losses. Trust your instincts and always buy based on sound criteria. This improves your success ratio over time.

No system is foolproof; but one mistake a lot of investors make is taking profits without also taking losses. To avoid ending up with a portfolio that has depreciated below your original value, match up profits and losses; set sell price points in advance; and never dwell on those decisions that go south.

Of course we learn from our mistakes, but that doesn't make losing any easier. However, the smart course of action is to keep your perspective, learn from your positive and negative experiences, and always make buy decisions based on sound, sensible fundamental choices.

To gain more perspective on insights to trading observations and specific strategies, I hope you will join me at ThomsettOptions.com where I publish many additional articles. I also enter a regular series of daily trades and updates. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site at ThomsettOptions.com to learn more. As a new member, if you buy a one-year subscription, you also get a free copy of one of my books, including this new one recently released.

I also offer a twice-monthly newsletter subscription if you are interested in a periodic update of news and information and a summary of performance in the virtual portfolio that I manage. Join at Weekly Newsletter I look forward to having you as a subscriber.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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