Why You Need A Strategy For Selling Stocks

By MoneyMorning.com.au

Last week, I explained the importance of managing your risk and buying at the right price, but this is only half the story when it comes to successful investing.

Not long ago, a subscriber to my resource investment newsletter Diggers & Drillers wrote to say:

The main issue for me is that stocks go up and come down, buying is a lot easier than selling. It would be great to get some idea as to DD’s strategy in selling.

You need to know when to sell.

This means that you have to have a sell strategy in mind from the get go, which also means managing your risk.

It may sound boring and repetitive but risk management is everything in the investing world – and yes, it involves knowing when to buy and sell.

The alternative, emotional investing, is never a good idea and often ends in heartbreak.

Let me give you a recent example of a sell recommendation to illustrate my point. When I came on board as the resource analyst for Diggers & Drillers last year, I immediately recommended a sell on Swala Oil & Gas [ASX:SWE].

At the time I issued the sell recommendation on Swala, I thought it was one of the most promising small-cap oil and gas companies on the ASX. So you may think it was a strange decision for me to issue a sell recommendation.

The thing is, as good as Swala’s Tanzanian story may seem, the biggest mistake any investor can make is to become emotional about a stock.

One of the greatest investors of all time, Roy Neuberger, figured out that the stock market is like the shoe business: you buy the shoes, you mark them up, and you sell them. You do not sit around holding them for decades. When a stock price goes up in price, you sell it.

Coming back to Swala, I came to the conclusion that for its current stage of development, the price had run too high. In other words, the risk of holding the stock outweighed the reward of selling it.

So at the time, I wrote to Diggers & Drillers readers,

Management says, The 2014 work programme intends to add to the joint ventures understanding of the unexplored portions of the basin.

Reading between the lines, I take that to mean that the company will focus on running additional seismic surveys over the region. In fact, I wouldn’t be surprised if they spent most of 2014 trying to map the fault line and gain a better understanding of the geology.

This will cost the company time and money, but for any explorer it’s always better to be safe than sorry. The likely impact is that the company will need to go through additional capital raisings and that the share price will drift through 2014.

Now successful selling involves two characteristics:

  1. Thinking logically – Swala has already done a lot of seismic but when it comes to drilling a well, you want to hit the juiciest spot. And this will require more evaluation, time and money. And on top of this, the company is focusing on numerous regions and projects – this means more time and money.
  2. Be disciplined – based on the original entry price of 14.5 cents, it was time to lock in the gain of 127.5%.

It may even run further in the future, it may even come to a point that I would recommend buying it, but don’t make the mistake of getting sucked into the long term story because it sounds good.

That said, let’s go deeper into the Swala story.

Swala’s management later told the market that they ‘may need to raise capital later in 2014 if it decides to progress with the contingent work programme.

And more recently the company announced, ‘the work commitment in this next period includes additional seismic acquisition and the drilling of 1 exploration well in each of the two areas to be completed before the end of February 2016.

My thoughts remain: how will Swala fund these development programs and drill a well with less than $10 million in cash (as at December 31, 2013)?

Sure the share price may go up, but with these concerns I was more than happy to have my readers take a profit.

It’s better to take the money off the table and put it into a company that’s more sustainable and that will likely make you yet more money.

The true art of investing is taking your profits – don’t be afraid to do it. As the wise man says, ‘you can never go broke taking a profit’.

Whether to hold or sell a stock basically comes down to the following:

  • Is the company growing at a reasonable and sustainable rate?
  • Is management hitting their targets?
  • What are the foreseeable capital investment requirements and are they manageable?
  • Do the project economics continue to stack up?
  • Is the share price significantly technically overvalued?

At the moment, all the companies on the Diggers and Drillers buy list stack up well. But this doesn’t mean my readers should rush in to buy them at any old price. We can’t forget about managing your risk when buying into the stocks, as I discussed last week. And as long as my readers buy in at the recommended buy-up-to prices and sell when my analysis says it’s the right time, they have a great chance at making solid gains.

Jason Stevenson+
Contributing Editor, Money Morning

Ed note: The above article is an edited extract from Diggers & Drillers.

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By MoneyMorning.com.au

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