Retail investors are famous for cutting the flowers and watering the weeds in their portfolios.
Warren Buffett
I heavily lean towards long-term investing when it comes to equity investments. My portfolio churn is minimal, while I do keep looking for new stock-buying opportunities to expand the portfolio. For direct stock investments, I follow the same pattern, and while I completely agree and have experienced (from my past mistakes on what Warren Buffet quotes), I do stick to some basic profit booking strategies. The strategy is aimed towards generating some acceptable degree of returns while the portfolio keeps building up over some time, and not truly maximizing profits or timing the market to the T!
Before I dive into the scenarios, I must emphasize the Primary Rule I follow – NEVER FULLY EXIT THE MARKET. If you perceive the stock market as an infinite play that will be hard to beat from any other investment form, every point in time is an opportunity of a certain degree. For individual stocks though, there is a danger of holding onto high-risk investments, which are weeds essentially. The point I’m trying to make here is, if you have a strong conviction (based on your analyzed data, and are not foolishly hopeful) on a “good” stock (the flowers), never exit fully. All the scenarios I’m going to explain below are about partial exits only.
Let’s begin with a few tax-correlated strategies.
Aligning with tax liabilities
If you do not understand the nuances of taxation, you will be unknowingly burning a lot of cash! So it is important to stay up-to-date.
Taxpayers get an INR 100K exemption annually from Long Term Capital Gains (LTCG). It becomes a no-brainer to hit that mark for any of your investments in green by booking profit. You could choose to repurchase your stock units the very next day, and pocket the gains tax-free for that financial year (ignoring significant price movement).
Secondly, during partial sell-off (be it stocks or even Mutual Fund units), ensure your brokerage handles the “Old Units Sell First” strategy. Most of them do so by default, but be sure about it so that you are not inadvertently making STCG (Short Term Capital Gains) which attract 15% tax instead of the 10% imposed on LTCG.
Taxation on gains from foreign equities is slightly different from domestic equities. These are treated as unlisted shares in the Indian market and hence the LTCG qualifies on a holding period of over 2 years (unlike 1 year for domestic stocks). So make sure not to miscalculate these!
There aren’t many other avenues for tax exemptions from Capital Gains in India’s Taxation System. One of them you could leverage though is Section 54F of the Income Tax Act wherein you can reinvest your gains in property investments to qualify for exemption.
Tax harvesting
Tax harvesting is a very common practice to manage your tax liabilities on capital gains. Essentially, you can set off your capital losses against gains. Unfortunately for taxpayers, it is not allowed the losses on capital gains head against any income from other heads. So here is what option you have essentially –
- Long Term Capital Loss can be set off only against Long Term Capital Gains.
- Short Term Capital Losses can be set off against both Long Term Gains and Short Term Gains.
Almost all brokerage houses provide a well-supported interface that gives your recommendation on tax harvesting. For example, Zerodha will show up something like this to help make an educated call on selling.
The next on the list are sell-off strategies I employ based on stock price movements. I possibly build positions on them later on based on different parameters (not explained in this post). I of course gain some and lose some.
Stocks at All-Time High
I follow my 2 thumb rules to book profits when a stock is hovering around its all-time high.
- The Price to Earnings (P/E) ratio is abnormally high from the last 3-5 years’ average P/E ratio. I take this as an indicator that the stock is in the overbought zone.
- The stock hits an all-time high and is then trading on around that zone (+/- a few %) for some time. The reason behind this is to ride some of the market sentiment and buy inertia, and not bet immediately against the market swing till the stock shows signs of weakening. Of course, no one can time the maximum, but this has helped premature exit many times.
Good stocks are meant to breach their all-time highs eventually. But their journey isn’t always linear.
Stocks that give rapid run-ups in a short interval
This ties somewhat to the P/E ratio mentioned in the previous section. The stock may not necessarily be at an all-time high but has given a strong run-up. There are always 3 directions from a stock level (obvious stuff)
- Stock corrects
- Stock trades in a range
- Stock price keeps moving up
Irrespective of what happens, in the mid to long run, the price to earnings does happen to self-correct to its historical levels. There is no universal P/E value for every stock. A growth stock can typically be trading at a relatively high P/E level compared to another stable one. Stocks also do go through re-rating which they call based on future growth predictions. But to keep matters simple, I go with the comparison with historical P/E and see if something looks overbought.
You could observe more small caps and mid caps exhibiting such run-ups. If you have ever heard of pump ‘n dump scams, the smaller market cap stocks are the ones susceptible to such swings. Most of the time retail investors fall into the multi-bagger trap, while it’s a market manipulation happening behind the scene.
Stocks swinging around Moving Averages Indicator
Day Moving Average (DMA) is a trailing indicator which as the name indicates shows the trailing X days average stock price. You should also understand EMA i.e. Exponential Moving Average which puts more emphasis on recent data points in the time series. You can get this information from any investing website, such as the below obtained from Screener.
Stocks breaching 50-DMA or 200-DMA indicate a level of bearish trend. (Trend of course reverse, but we are not accurately predicting the future here!) I generally try to catch some of these MA trends to exit some positions. I do not always look at this in isolation, but mix it with the P/E numbers to make my judgment.
You will find a ton of short-term market indicators, a lot of them used for trading purposes. But we are not talking about trading here. Instead, a more time-spread view of investment.
Balancing allocation in a particular sector
While stock picking, we generally build up positions in common sectors such as Banking, Tech, Infrastructure and likewise. While picking up a candidate for profit booking, I look for a hedge on good stocks in the same sector. Market sentiments apply a lot of times to the overall sector. So the price movements can be collected and correlated on multiple stocks in the sector. Let’s assume I have HDFC Bank and ICICI Bank, and a few other banks in your portfolio. Going by the indicators mentioned earlier, if pick up ICICI Bank as a candidate for booking profits, the rest of the bank sector portfolio gives me a short/mid-term hedge against the sell-off I’m doing on one stock.
Lastly, and most importantly, I keep a reinvesting plan at my disposal, unless I am deliberately building a cash position for the future. The intention of all these profit bookings is not to park cash without a plan which makes no sense but to rebalance the investment portfolio.
