Accounting for profits: how do you know when to recognize profits on an investment?

DK Aggarwal

Making a profit on your investment is as important as making the investment itself. When investing in stocks, it is essential to be aware of all the factors that can affect market movements and which ones can affect the stocks you own.

There are four main situations in which investors should not delay profit booking. These are:

  1. Company specific news: If there is positive news about the company, such as business expansion or new product launch, it creates a positive sentiment about the stock in the market. This positive sentiment would lead to investors buying stocks more than usual, and eventually the stock price would rise. When the stock price is rising, one may be able to achieve the investment objective by selling the stock. A recent example is , which saw a solid price rise after news that its coronavirus vaccine was found to be more than 90% effective in preventing infection.
  2. Earnings indicator: If the quarterly earnings of the company whose shares you own are good and above expectations, keep holding them. If the underlying variables change in a way that may impact trading operations, then consider reducing your stake or selling the shares. Additionally, you should sell a stock when you see better opportunities that have the potential to generate higher returns.
  3. Sector News: The recent announcement by the RBI that it has streamlined the risk weighting of new mortgage loans sanctioned until March 31, 2022 and linked them to loan-to-value (LTV) ratios has boosted mortgage lenders. The market immediately priced in the rise in profitability and its positive impact on the market valuations of these lenders. There has been a smart rally in these stocks due to this positive sentiment based on the expectation of a spike in demand for home loans. On such sharp rallies, one can take profits if there is uncertainty about the sustainability of the rally.
  4. Economic indicators: Economic data plays a very important role in deciding the market movement and hence can be an index of accounting profit. Positive economic data boosts investor confidence while weak data derails that confidence. Weak data forces investors to sell stocks at the current market price. When a person sells shares at the current market price, they actually lock in the gains and protect themselves against financial losses.

It is important for an investor to stay informed and do thorough research so that they can record profits at the right time. An investor can get the best returns on investment by booking profits in a well-planned and timely manner.

Also, while making a profit, ideally only cash out a small portion of the investment, as this can provide a double benefit. First, an investor can secure the profit on a certain part, and second, the rest of the investment will continue to grow. Overall, the most important thing in all of this is timing.

(DK Aggarwal is the CMD of SMC Investment and Advisors)