Stock Selling Strategies - Sell Half of a Stock That's Doubled

Investing entails risk. But what if you could eliminate the risk in some of your investment? Wouldn't you want to do so?

In fact you can if you are fortunate enough to have a stock that's doubled in price. And that is the basis for the strategy of selling half of your investment in a stock that's doubled. By doing so you recoup 100% of your initial outlay and have a risk-free ride on the remaining stock.

This is a very popular selling strategy followed by many people. And recommended by some analysts. Ryan Irvine and Brent Larsen at The FutureStock Review frequently suggest that "taking profits on at least half your position would be a prudent strategy" for previously recommended stocks that have doubled or more.

And Pat McKeough, who generally recommends stocks for the long haul, acknowledges that "it pays to apply the sell-half rule" to high risk stocks, "penny mines or junior technology companies that don't have any real profit history".

But what if you've stumbled onto the next Microsoft? McKeough says you can always buy more after the company becomes profitable.

There's another reason for applying this rule besides eliminating risk. And that is to re-balance your portfolio. Suppose you bought shares of a speculative but promising stock that doubles in a short period. All of a sudden it makes up a much larger percentage of your portfolio. Do you want to be that exposed to the possibility of a sudden reversal?

Suppose, for example, that you have a $100,000 portfolio and you have invested $5000 in a stock that suddenly doubles. Now it makes up almost 10% of your portfolio. If the price falls back to its original level, a distinct possibility, you've wiped out 5% of your portfolio value. But if you sell half when it peaks, a reversal still leaves you with a 50% profit, wiping out only 2.5%.

So you've got a stock that's doubled and you sell half. What now? What do you do with the proceeds?

You can eliminate your risk of losing your seed capital completely by re-investing it in fixed income securities. Not very profitable, but absolutely 100% safe. This might be a good strategy if you're close to retirement age, but still actively investing. Your nest egg is then safe, and the remaining stock is "mad money" to take a chance with.

More likely though, is that you are still a bit away from retirement. In that case, you would likely re-invest the money in another stock, thus diversifying your portfolio.

One variation of this strategy is to continuously repeat it. If the stock doubles again, sell half again. And so on.

Another: if you believe the stock you are invested in has tremendous potential, in other words, another Nortel or JDS Uniphase, you can make the rule "sell half on the triple" That way you lock in a 50% profit instead of just recouping your initial stake. Or you can "sell a third on the triple", recouping your stake and leaving twice as much to ride the stock higher.

McKeough makes a brilliant suggestion for people who have made a killing on a stock inside their RRSP. Sell half to nail down the profit, then swap some or all of the remainder outside the RRSP into your personal portfolio. The stock is recorded for tax purposes as being bought at the price it is swapped out at. So if it declines instead of going up, you have a tax loss you can declare against taxable capital gains.

In fact, if you swap out for a stock that has lost value but which you expect to gain, you get a tax loss right away without losing the stock. And if the stock recovers as expected, the gain is sheltered. The tax loss may even offset a gain that the stock you swapped out may make. Anything to keep your money out of the hands of the revenuers is a plus in my book!

There are a few downsides to selling half when a stock doubles. The main one is that you may be selling out too early. The stock may still have tremendous potential. If that is the case, you can console yourself in the fact that you still have half of your investment and you are participating in the bounty, though not as much as you would have by holding.

Another downside is that, maybe you should have sold all of it! Maybe the stock will decline back to its previous level. If that is the case, you're still better off than by not having sold half. You're still in a profitable position. It's just a reduced profit.

But the most serious downside is that you now become complacent about the shares you've hung on to because, after all, they're "free". It still makes up part of your portfolio and, although you may allow it more leeway in fluctuations, you should still have a selling plan if the stock sours. Never be complacent.

Summary of Advantages and Disadvantages
of the Cutting Your Losses Short Strategy

Advantages	Disadvantages
Preservation of capital.	The stock could continue to rise.
Risk reduction.	The stock could go down. (You should have sold it all.)
Rebalancing portfolio.	Could become complacent about shares you keep.
Peace of mind

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