When is the best time to exit from a stock?

In Mahabharata, there was a character called Abhimanyu (son of Arjun), who knew how to enter the Chakravyuha but was not aware of how to exit. Abhimanyu died on the battlefield. In investor circles, there are many Abhimanyus. They know when to enter the stock, but fail miserably when it comes to exiting. The end result — they incur huge losses.

One has to be Arjun of the stock market, with proper entry and exit strategies in place.

Else, even if you buy at the right level, chances are high that you may not make money. Ask investors who bought Vakrangee, P C Jewellers, Manpasand Beverages, to cite a few examples. Before they crashed, these companies moved up substantially. Not many could sell them at the appropriate time and are sitting on huge losses.

If one were to scan the available research reports at any point in time, one would find more ‘Buy’ reports than ‘Sell’ reports. The number of ‘buy’ reports invariably goes up when sentiments are good.

Normally, the ‘sell’ reports start circulating only after the scrip corrects significantly.

Probability is very low that you would act on-sell reports. Once you have seen higher prices, it becomes a mental block for investors to sell the stock at lower prices.

The dilemma investors face: when is the right time to sell a stock?

While there are no sure shot answers, I would suggest a checklist that could help investors to make the right decisions.

Should you buy or sell when everything is going right for the company?

This is the most fundamental question people need to ask! In my 25 years, I have seen the maximum ‘buy’ calls on the company when everything is going right.

We would even see stories about the company, making them superheroes. Good publicity lures more investors to buy the stock, pushing the share price further up.

My suggestion is that when you see maximum ‘buy’ calls with a good amount of media coverage it’s the best time to sell a stock because this is when everything is going right for the company is already priced in.

Sector fancy

Another mistake many investors make is that they buy companies from the sector that is hot. The common belief is that while other companies from the hot sector have moved up, the company that you have zeroed in has not, and hence let me buy the same.

However, when the fancy for a sector is at its peak, it could be a good time to reduce the exposure, rather than increasing it.

Let me cite a few examples. Many investors increased their allocations to tech stocks in 1999 and 2000 when the sector was about to peak. A similar trend was observed in 2007-08 for the infra sector. We should not forget that some mutual funds also launched new schemes at the peak of the sector cycle to garner more funds from the investors.

Needless to say, these schemes underperformed in a big way.

Law of average

This is one of the most powerful tools in the market, but very few people realise it. The stock that has moved up has to attract the law of gravity one day.

One does not know when that would happen, but going by the past share price movement, if the scrip has moved up the most in the last 10 years or so, the probability of the scrip underperforming increases.

For example, Larsen and Toubro were one of the best-performing stocks in the 2007-08 rally. But since then, it has been struggling to give meaningful returns to the investors. Over the past 12 years or so, its CAGR is a mere 2.5%—much lower than the safe government bond.

Corporate governance issue

Investors have become extra sensitive to the corporate governance issue. The moment they smell a rat, investors want to move out of the company at any cost. Manpasand Beverages fell drastically-the moment the issue of corporate governance surfaced.

Vakrangee is another example. We have recently seen how CG Power share price tanked. The moment one gets a foul whiff on corporate governance, it is time to move out immediately. Even if it means incurring losses.

But…

But there is a possibility that the share price may move up after you moved out of the company. Don’t repent. No one is able to sell shares at the top of the price. It is critical for investors to realise that the profits booked are more important than book profits. How effectively one uses exit strategy would decide the quantum of wealth one can generate from the equity market.

(The writer is the Chief Investment Officer, MarketsMojo.com)