Let’s say that you own a stock and that stock just spiked 20% in a single day, what should you do?
It depends! (that’s the usual answer isn’t it?) Like anything else dealing with money, you always have a plan to get in and a plan to get out. Take, for example, buying a car. You don’t buy a car without thoughts on how you’re going to sell it (or otherwise dispose of it, like giving it to your children, or nephew/niece, or whatever), that’s why people care about the resale value of a car… it’s how you get out and get into a newer car. Well, the same applies to a stock right? Ahhh… see this is where people slip (myself included) because they think that they will be able to tell when they should get out as the stock moves. That’s why you see people talk about 1000% gains on paper that get realized and are either tiny gains or even losses (dot com anyone?).
So, back to the question at hand, up 20%, what should you do? Depends on your game plan. If you did your analysis (to be honest, I don’t do much analysis, that’s why I stick most of my money in target retirement funds or index funds), you should know where your exit point is – is it +20%? If so, then you want to get out now. Is it 30%? Then you’ll want to wait a little bit.
How do you determine this exit point? One common approach, which is how analysts often issue price targets, is that you take the return on equity (or some other return number) and apply it to the stock price. Has the company shown ROE or ROI (or whatever) of 15% each year for the last five years? Ten years? Then you’ll want to project that onto the stock price to see where it goes. If the price spikes 50% in six months, perhaps you want to take advantage of the exuberance and take some money off the table.
Either way, the point is that the 20% gain doesn’t matter in a vacuum, it only matters in the context of your overall investment plan.