Investing Tip: On Selling Stocks

By Timothy Lutts, Chief Investment Strategist and Chief Analyst, Cabot Stock of the Month
From Cabot Wealth Advisory 6/13/08 Sign up for free Cabot Wealth Advisory e-newsletter

Buying stock is easy. You find a stock you like; you envision the profits you'll reap in the weeks and months ahead as your stock soars. And you buy, with a heart full of hope.

Selling, on the other hand, is difficult. Most beginning investors sell wrong. They take small profits on stocks that then go higher. They fail to sell their losers, telling themselves the stocks will rally, that the market, in effect, is wrong. And they end up with a portfolio of big losers and no winners!

If you want to end up with a portfolio of big winners and a few small losers, you have to reverse your thinking. You have to hold winners and sell losers.

For example, last May, Novatel Wireless (Nasdaq: NVTL) was added to the Cabot Market Letter Model Portfolio. The fundamentals promised great future growth and the stock was in a strong uptrend. Unfortunately, just two months later, our small profit disappeared when the stock fell through its 50-day moving average on heavy volume. We recommended selling and got out the next day at 21, taking a loss of just 1%. The stock did rally for a while, but by the end of the year it was down to 16 and by this April it was down to 7!  If we had stayed with it, saying, "but the fundamentals look fine!" our loss at that point would have been 65%! (Since April the stock has rallied; it's now up to 11.)

In short, selling the loser quickly prevented us from having to deal with a much larger loss. When it comes to winners, on the other hand, patience often pays.

For example, back in March of last year, Cabot Market Letter bought First Solar (Nasdaq: FSLR) for the Model Portfolio. The company was young and growing fast, and the stock was strong. The profits accumulated fairly quickly. By early July, our stake had doubled! In fact, we actually recommended selling a third, because the stock appeared due for a correction (the correction lasted three months), and because we wanted to reduce the over-weighted stock's effect on our portfolio. 

In October, we again sold a third of our holding for the same reasons after the stock gapped up on good news. This left us with about 44% of our original shares...and this time the stock kept climbing. 

Then in early January, with our profit at 288%, we advised selling another third. The main reason this time was the broad market's weakness—acting defensively, we brought the portfolio's cash level up to 60%—while the secondary reason, once again, was to reduce the stock's excess influence on the portfolio. After this sale, we had 30% of our original share left.

And then we sat patiently, while the stock dropped to nearly touch its 200-day moving average at the market bottom. (All the while, of course, the news out of the company has been great.) Since then, the stock has worked its way back up to new highs. In the meantime, we've seen more young solar stocks enter the arena (ENER is very impressive and has been mentioned here before). We've also seen many of the original strong players lag far behind (STP, SPWR, ESLR).  But First Solar has proven worth keeping.

Now, you might argue that if we had sold none of FSLR along the way, our profit would be even bigger today, and that is true. But our risk would be higher, too, and you need to always balance risk and potential reward. By selling portions after strong upmoves, we reduced risk at the right time. But by keeping the majority of our position after each sale, we cultivated a long-term holding that's still among the leaders of a high-potential industry.

In sum, by buying smart, selling losers quickly and letting winners run, the Model Portfolio now consists of eight stocks (when it's fully invested there are 12). Three are rather large winners, four are small winners, and one—bought June 5—is a small loss. And the portfolio is up 0.5% year-to-date, while the S&P 500 is down 7.7%.

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