Profit taking is an acquired skill. Most early traders or investors struggle with profit taking. Sometimes, after taking profit, the price keeps going higher, making them feel like they’re missing out. Other times, they don’t take profit then the price crashes and they lose all their profits.
With profit taking being so difficult to master it leads to the topic of this post. I’m going to share some key insights I’ve learned with you when it comes to profit taking. It’s a constantly evolving process for me, but hopefully, this can offer some insights.
Disclaimer: None of what I’m talking about should be considered as financial advice. It is for entertainment and educational purpose only.
Greed Is the Enemy
It is great to see your investments go up. However, what goes up must come down eventually. The problem is we don’t know when it will come down. The unknown of when the price will come down makes you think of how much more profit you can possibly get. This greed of getting more profits prevents you from taking any profits.
Guess what happens next? The price starts to come tumbling down and wipe out a large portion of your profits. Just like that, a bulk of your profits are gone. Then you wish you could have sold at the higher price when you had the chance.
It is important to recognize that greed will get in your way when it comes to profit taking. Once you accept greed will be present, you can make a plan to overcome it.
It’s Impossible to Call the Top
It seems so simple to have your strategy be to buy at the low and sell at the high. In practice, it is near impossible because you only know the low and high after the fact. How do you know if a certain price was the low? When the price reverses and never goes back down to that point. Similar concept for the top except it is opposite.
There is realistically no way to know if a low or high is in while it is happening. So, if your plan is to buy at the low point then sell at the high point you’ll need to re-evaluate your plan.
It’s Not All or Nothing
A common mistake that less experienced traders or investors make is that they put all their capital in investments at once. This applies when they are trying to sell too. It is simple to do but can lead to so many problems in terms of emotions.
Imagine selling an investment entirely only to see it go up significantly after. Suddenly this brings greed into the picture and it usually doesn’t end well. Next time instead of selling, greed will make you want to take profits at the very top. Although this example seems illogical, emotions are complex and don’t fall under logic. If you’ve been emotional during an investment or trade you’ll probably understand.
An example to help with overcoming the all-or-nothing mindset is to think about a T-bone steak. What would you want more from the T-bone steak? The meat or the bone if you can only choose one? Most would answer the meat, in this case, it is the majority of the profits. It would be nice to have the bone too, but you can do without it.
Have a Plan
Having a plan is important to be successful in profit taking. The reason why is because when you have a plan you would be less likely to act on your emotions. When you act on your emotions that is when it usually ends badly for your investment or trade.
Consider the situation where an asset rises 100% and you didn’t have a plan. Your tendency might be to just let it keep going up. The issue is that there is no telling whether the price will go up or down. If it goes down you’ll be kicking yourself for not taking some chips off the table.
Now suppose the asset rises 100% and you have a plan. It’s a simple plan like taking 50% off the table when the price appreciates by 100%. You have sell orders in place to carry out your plan. Half your investment sold then the price starts falling. In this case, you’ll probably be happy that you took some chips off the table.
Preserve Initial Capital Invested
Any investment comes with a risk. Wouldn’t it be nice if you can make an investment 100% risk-free? Well, you could get close to having a risk-free investment. After an investment gone up by a substantial amount (depends on what is substantial to you) you can take enough profits to cover your initial investment. Now, you can let the remaining investment ride knowing that you’ll be profitable as long as the asset has some value in the future.
You might be thinking that you’re giving up potential profits by taking your initial capital back. That is true, but investing is a long-term activity. The habits you have will be more important in the long run than trying to squeeze a bit more out of an investment.
Which situation would you rather be in? A few winning investments where you can still lose all your capital or a few investments where you can at worst break even. Given the option, I’m sure many would choose the second option. That’s precisely the situation you’ll be in if you take your initial capital investment back after substantial price appreciation.
Scale Out
No one really likes knowing that they left money on the table. It’s a good problem to have to see your investment goes up even higher after you sold. However, that’s still a problem to know you’re missing out on too much profit. To capture more of the profits you can expand your plan to take profits by scaling out.
For example, you can have different tiers for a price range. Maybe on the low tier, you’ll scale out by 1% a day. On the medium tier, you’ll scale out by 3% a day. On the high tier, you’ll scale out by 5% a day. On the moonshot tier, you’ll scale out by 10% every hour.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
If you’re new to investing and need a guideline to help you start your investment journey you can check out my post on setting yourself up for financial success. I also have a post about beginner mistakes to avoid in the stock market.
To get in touch, follow me on Twitter, leave a comment, or send me an email at steven@brightdevelopers.com.