If you fail to plan, you plan to fail.
Judging from many books and investment web sites, it's all about stock picking. That's all there is to it. Just buy the right stocks at the right time and there's no need to think about when to sell, let alone think about how to manage your stock position while it's in play.
In this article I encourage you to think about the entire lifecycle of an investment by taking inspiration from the day trader, the position trader, and (of course) the investor.
The Day Trader's View
A day trader will not even enter a trade unless he has already figured out when to exit the trade, so from his point of view the lifecycle is all about entries and exits.
The day trader's entry criteria will be of little interest to us Fools, and nor will his exit criteria for that matter, but we should be interested in the fact that he thinks about his exits before he even enters new trade. He won't go in without an exit strategy.
For the record, his exit criteria might be something like: I will exit with a manageable loss if the price falls by 10 points; or at a profit if the price rises by 50 points; and in any event at the end of the trading day.
The Position Trader's View
In my preferred longer-term 'position trading' approach, I think not only about entries and exits but also about what happens in between; what I regard as trade or investment 'maintenance'.
While one of my longer-term trades is in play I am periodically thinking about:
- What should I do if it performs well? Add more funds in the process known as pyramiding, or take some profits?
- What should I do if it performs badly? Add more funds so as to average down my purchase price, or exit before a small loss becomes a big loss?
- Should I trail my protective stop order, and if so, how close?
Actually, I think about those things before I enter a new position in the first place, so that when the time comes I know exactly what I need to do. I regard my position trading strategy as working when I spend more time on trade maintenance than I do on entries and exits.
The Investor's View
For many investors, the investment lifecycle can be distilled into the picture below.
Yes, for many investors, that's it. It's all about entries, with no thought given to maintenance and exit. Just buy the right stocks at the right time, and hold on regardless.
Failure to have an exit strategy means that there is really only one time you will sell: not at the best time for taking a profit before it slips away, not when a loss is still small and manageable, but when you really need the money. And we can all guess where stock prices will be sitting at that time.
Now let's look at this from a Foolish perspective. If you buy a stock because it has a P/E of 10, do you plan at the outset to sell it in whole or in part when the P/E reaches 20? If you buy a stock because it has a positive net asset balance, do you know in advance that you will sell it if the net asset balance turns negative? Don't tell me you've not even thought about it!
Well, here's something for you to think about while 'maintaining' your stock investment. When it generates those juicy dividends that you are hoping for, what will you do with them? Take them as cash? Recycle them automatically into the same stock? Or use them to fund new purchases, thereby initiating an entirely new lifecycle on a new stock?
Foolish Bottom Line
Thinking about maintenance and exit before entering a new stock position or making a new investment has nothing to do with prediction. We really have no idea how a stock's price will perform in the future, or how its fundamental ratios will change over time.
But we can certainly plan ahead so that we know exactly what we will do under various circumstances while our position is in play and when it comes to an end. Here is your starter for thinking about the entire investment lifecycle:
And don't forget, as the old saying goes: if you fail to plan then you plan to fail.
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