MARKET COMMENT
The Pros & Cons of Profit Taking

By David Kuo (TMFDragon)
November 12, 2001

Carburton Street, London -- Making a profit on your investment is really what this investing business is all about. Investors buy shares in a company in the hope that, some time in the not too distant future, those shares will appreciate in value. As a Foolish investor you know you should only invest with money that you don't think you'll need for the next five years. That way, if those shares happen to fall, you're not going to be too distressed about it. A bit peeved, maybe, but not too anxious. However, you're not out to buy shares to watch them fall in value. You're going to want them to go up in price, right?

So what happens when those shares start to appreciate in value? These profits are simply an unrealised gain and are known in the trade as a paper profit. Those profits are calculated from the difference between the current market price and original purchase price of those shares. In theory they are profits but those profits are not crystallised until you actually sell those shares and bank the cash. Once you've completed the sale that paper profit becomes real lolly that you can go out and spend or buy even more shares.

But many investors seem to have a slight problem deciding when their shares are overvalued. Those same investors have little difficulty in deciding when to buy shares. They appear to have a fairly good idea of when securities in a particular company are undervalued. But the same cannot be said when those same shares start to look a touch expensive. It would seem that our ability to rationalise a company's value becomes clouded by that worst of those human failings, namely human greed.

Deciding when to take profit is not an easy task. But there is a well-trodden saying in the market that might help, namely "you can't go broke taking a profit". This simple approach to investing might leave you less well-off should those shares continue to climb. You need to balance the gains you have made already against the company's current valuation. If may be that, even though the shares have risen, they are still undervalued.

But if you are happy with the gains that you have made then don't look back on what might have been. However, if you are in the fortunate position of being able to take profits on a regular basis then be sure to watch those broker commission charges because they can soon eat into your gains if you trade on a regular basis.        

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