The old cliché of what goes up must come down also applies to highflying stocks, however this is not true in every circumstance.
It is still worth noting that any time a stock has had a serious run-up it is not unreasonable to expect that investors will take profits off the table and in doing so lower the share price.
Buy-and-hold investors should not consider their portfolio on autopilot. When they experience a significant run-up in a stock's price it is time to reconsider how much the change has impacted your whole portfolio. Incidentally, the same caution applies when a stock has dropped significantly.
In many cases, a normal rebalancing of your portfolio will correct the problem, however in cases when a stock has risen dramatically faster than the market as a whole you may want to act before you would normally rebalance your portfolio.
If you have a stock that is has experienced a significant run-up, consider selling part of it and reinvesting the profits in other areas. How much you sell is, of course, a personal decision based on your individual situation.
However the point for all long-term investors is don't let a stock that has grown significantly reach that point other investors begin selling and you lose your profit.
When is the best time to buy or sell a stock? There are many tools to help with this decision, but one of the first steps is to make certain your decision is based on facts and not emotion.
That may seem obvious, however the truth is that many decisions we make every day are tainted by our emotions in some way. There is a growing body of evidence that we are all less disconnected from our emotions than we believe.
This can be seen with dramatic consequences when looking at how emotions affect investing in the stock market and other securities.
The media calls the phenomena a "bubble" and we all know what happens to bubbles eventually, whether it is a bubble in an individual stock or a segment(s) of the market. The history of investing recounts many bubbles in the past, so they are not a new problem. Some of the more recent bubbles include:
- The dot.com bubble
- The housing bubble
- The financial derivatives bubble
All of the bubbles have some things in common. They are marked by excitement in the market as investors read stories of instant fortunes (think of the technology stocks that soared in the early days of the dot.com bubble).
When excitement builds around a stock, industry or some other investment, prices soar as demand outpaces supply. Many investors can't stand the thought of missing out on huge gains and jump into the market, which only drives up prices further.
So far, so good, right? You buy and prices go up. The question no one has an answer to is how big is this bubble? Market dynamics also most guarantee that at some point gains will diminish and selling takes over.
At this point the bubble is in the process of bursting and if you aren't out, you will likely lose most if not all of any gain.
So, when do you get in and when do you get out? Here are some suggestions to consider:
- Most investors enter bubbles after most of the initial gains have already occurred, meaning you are buying in at a higher level than the initial investors.
- When the smart money decides to cash out, prices can fall dramatically and quickly.
- Set a modest profit goal and take those profits out of the market regardless of whether you believe there are more gains to be had. This requires discipline that many investors don't have.
- Don't risk your retirement or your children's education chasing quick profits. If you want to chase bubbles, put no more than 10% of your investment assets into the game (5% if you are less than 10 years from retirement).
It is OK to acknowledge the emotional charge of investing in the hottest new trend, just limit your exposure to prevent any real, permanent damage.