Before we delve into a discussion about partial profit booking, readers may want to do some ground work. In an earlier article, I had given three reasons why you should sell a stock from your portfolio completely. Prior to that, I had written an article about asset reallocation.

Selling
a stock totally from your portfolio may or may not generate profits -
because the reasons for selling are to avoid a loss because of faulty
stock selection or worsening company fundamentals; or, to generate cash
for emergencies.

Your timing of selling may not coincide with
a bull period, which means you may need to sell at a loss. It is
important to note this point, because as human beings we are 'loss
averse'. That means, taking a loss causes a bigger emotional upheaval
than making a big profit. But prudence demands that some times you do
have to sell at a loss - to avoid a bigger one.

Partial profit
booking is a different skill altogether. Here, the reason and timing of
selling is totally in the investor's control. When and how much
quantity you sell depends on your skill and risk tolerance. The profits
you make will depend on it.

Here are a couple of reader comments, that are good examples of why you need to learn the art of partial profit booking:-

1. 'I bought a stock at 37 and saw it go all the way up to 180, but did not sell. It came down, and I finally sold at 120.'

2. 'I
bought a stock at 18. When it went up to 44 within 3 months, I sold it
all. To my horror, the stock kept going up and hit 150. I have learned
that to make big profits, one has to hold the stock for a long time.'

Both
situations happened during a bull phase. Both investors made decent
profits, but missed out on a much larger profit potential. Let us learn
how partial profit booking can help.

Firstly, you need to buy a
decent quantity of shares - at least 300 or 500 - of each company.
Buying 50 shares or 100 shares won't work very well. Secondly, you need
to decide whether a particular stock is going to be part of your core
portfolio (80-90% of your total portfolio value) or your satellite or
'mad money' portfolio (10-20% of your total portfolio value).

The
core portfolio should comprise fundamentally strong large-cap shares
which should be held 'forever'. You should add to this portfolio near
bear market bottoms, and book partial profits only near a market top.
Otherwise, just sit back and enjoy the dividends and bonus issues, and
subscribe to the rights issues. Good large-caps find various ways to
reward their stakeholders.

The satellite or 'mad money'
portfolio usually contains more risky and relatively unproven mid-caps
and small-caps. These shares may shoot up like a rocket in the
short-term, and collapse in a heap some time later. This portfolio
requires closer monitoring, and partial profit booking is a must during
bull phases.

Let us assume you had bought 500 shares at 18. You
may have set a target - based on technical analysis or fundamental
analysis (or both) - at 40 in 3 years. More than 100% returns in 3
years isn't bad at all. Expecting more than that would be bordering on
greed.

To your pleasant surprise, you find the stock shooting
up and crossing your target within 6 months. What should you do? Sell
200 @ 50, which recovers your original investment plus the 10%
short-term capital gains tax (of 640). The balance 300 shares have
become 'free', i.e. there is no holding cost for you.

So,
enjoy the bull ride by keeping a 'trailing stop-loss' of say, 10%. That
means, at 100 the stop-loss will be 90. If the stock moves to 150, the
stop-loss should be 135. Sell the shares as soon as your stop-loss is
hit.

If you are lucky enough to hold the entire 500 shares
through the bull phase and sell it at the very top, then you will
obviously make more money. In reality, picking exact tops and bottoms
are next to impossible.

Partial profit booking reduces the
risk considerably - first by pulling out your original investment;
then, by letting profits ride on the balance quantity to the maximum
extent possible. It also ensures that you will not make a loss.

(Note:
Partial profit booking works in a bear market also. You 'short sell'
when the market is falling, and at each drop you buy back a portion of
the amount short sold. This strategy is not recommended for
inexperienced investors.)

As posted on http://investmentsfordummieslikeme.blogspot.com/