We all know the importance of investing as it is the most important aspect of wealth creation. While a steady source of income is necessary to feed the investments, it is also important that we invest in instruments that can create profits and not erode our capital. Today we have an array of investment options, however, investing in stock markets has the potential to generate maximum returns as compared to any other options even though the risk of investments is quite high.
The key question that every investor and trader faces is what strategy or techniques to use to make profits from stocks in the face of market volatility and safeguard their investment at the same time. Some of such key profit-making strategies are highlighted below.
What is a profit-taking strategy?
There are various investing and trading strategies that investors and traders can access easily. Some of these strategies are easy to understand and simple to identify but the core of these strategies is to enter and exit the markets at the most opportune positions that can help in maximizing the profits on investments. This is the overall meaning of a profit-taking strategy. If the core principles of stock investments and trading are not clear, there is a high possibility of making losses. Therefore, before jumping or following any profit-taking strategy, it is essential that the basics of stock markets and the concepts like fundamental and technical analysis are understood.
Read more : How stocks make money for you?
What are some of the key profit-taking strategies?
Some of the standard and popular profit-taking strategies are mentioned below.
- Booking profit when the stock loses momentum
Most traders and investors think a stock or the market goes into a downtrend when the sellers are dominant. While this is a fact, it is not entirely true, the onset of a downtrend in a stock, commodity, or the markets, in general, is when the bullish rally loses momentum or when the buyers thin out of the market. This is the ideal time to lock in the profits and exit the markets as it is nothing but a slippery slope hereon.
- Book profits immediately on a dicey trade
Buyers are constantly on the lookout to tap into lucrative investment opportunities. When we come across a stock that is gaining huge momentum despite not being backed by strong fundamentals, the scenario is too good to be true. The market will definitely correct such momentum which is short-lived. Therefore, it is ideal to exit the trade as soon as possible even with the limited amount of profit in order to avoid huge losses when the downtrend is set. Hence, the important thing to remember in such scenarios is if the stock is not fundamentally strong and is rallying without any adequate supporting base, such trades are quite dicey and when the trader or investor is in a profitable position, it is better to book such profits and exit.
- The liquidity crisis in the market
Liquidity is a powerful factor affecting stock prices among various other factors. The government under its monetary policies often tightens the liquidity in the market due to issues like inflation. Also, when foreign investments start draining from the market, it is also an indication of the coming illiquidity of the market. This will result in a reversal of the current trend and therefore, it is advisable in such cases to immediately lock in the profits and exit the markets.
- Buying when the stock has proven profitable and selling it quickly
Most investors and traders often think that the best strategy to make profits in stock markets is to buy early and hold for a long time. This is a proven fact to earn high profits, however, it is not always possible to estimate the most optimum entry-level to maximize profits. Also, for novice investors and traders, analysis of the most profitable stocks may be difficult initially. Therefore, in such cases, one can watch for stocks that are on a rise and are backed by strong momentum and fundamentals that further fuel their uptrend. Investors can then buy such stocks and exit their positions when they have earned nominal to moderately nominal profits. This will help them get assured returns and secure the profitability of their portfolio.
- Scale the sale of holdings
Another important tip to maximizing the returns is by exiting the holdings gradually instead of in one shot. By gradually diluting the holdings, investors can average out the returns and primarily secure the recovery of their cost of investments. However, this strategy can be applied only in the case of profitable stocks or stocks that are continually showing a good rally. In the case of stocks that seem to have a windfall gain and are bound to lose their ground soon, it is advisable to exit all the positions as soon as possible.
- Set a target sale price and stick to it
The golden rule of trading, especially for novice traders, is to set a target price or profit margin for their holding and stick to it. When such a target profit margin or price band is achieved, it is prudent to exit the market and not be greedy. There have been multiple cases when traders have seen their profit margins completely disappear in the hope of gaining excess margins more than their targeted ones. An important thing to note in this aspect is to set the targets based on concrete technical indicators and fundamentals to back their analysis and targets.
- Aim for achievable profits to scale up overall portfolio returns
One of the biggest mistakes that most traders and investors often do is to miss the actual returns in the hope of gaining more. Everyone wants their investments to double or more but it is not always possible and in the hope of such extraordinary profits, the actual profits are often ignored. Therefore, it is important to realize achievable gains and gradually increase the overall profitability of the portfolio. For example, the possibility of realizing profits in the range of 20% to 25% for a stock is much more feasible than 100%, especially in the short term. Hence, it is always better to aim for achievable returns rather than wait for unrealistic ones and gradually scale up the overall portfolio returns.
Profit-making is the sole aim of any investing activity, whether it is in stock markets or in any other investment option. However, while earning profits it is also important to preserve them and not take rash investment decisions that can erode already earned profits as well as the capital investment. Investors and traders often use multiple strategies to earn profits but the basis of such strategies should always be a deep understanding of the market’s fundamentals and the investor sentiments that affect the price movements.
The three key types of profit-making strategies based on investor perception is achieving conservative profits, achieving the most optimum profits, and using both the above techniques to gain maximum returns.
Most investors believe that if a stock jumps about 20% in a 3-week period and is backed by strong fundamentals, it has the potential to achieve huge margins in the 8-week period. Hence, such stocks need to be held for a period of 8 weeks to gain maximum returns.
The biggest disadvantage of a conservative profit-making strategy is that the investor or the trader will not be able to tap into the full potential of the stock to make profits and will exit their positions with nominal returns.
Yes, a periodic review of the portfolio is an essential profit-making strategy as it will help in weeding out loss-making stocks and including stocks that can further push the portfolio profitability on the higher side.