I don’t think enough is written about the proper time to sell stocks. We’re all interested in learning what to buy, but protecting gains and/or limiting losses is equally important. Selling a stock correctly can be just as fulfilling as spotting a great value play at the right time. It’s all about money — and holding on to as much of it as possible.

Nothing irks me more than watching unrealized profits disappear, or worse, turn into unrealized losses. Yet many of us saw that happen often in the 2000-02 bear market, so these experiences are still fresh in our minds.

The question of when to sell remains a critical one. You should ask it of yourself before you even buy a stock. When you enter a position, you should know at the outset what would make you exit. Here’s a checklist of issues to address as you contemplate your purchases:

• What’s your target price on the stock?
• What if the stock goes against you?
• At what point will you bite the bullet and admit you were wrong?
• What will you do if the dividend is reduced?
• What if the dividend is omitted completely?
• What if the stock appreciates much faster than you anticipated and starts to break down on heavy volume? Do you take your profits, or hold on with the hope that you’ll do even better over the long haul?
• What will you do if your stock is downgraded?

I can’t answer these questions for you, as only you know your own goals and risk tolerance. However, I will share my own thought process, which I undergo before buying a blue-chip dividend-payer on my watch list.

1. I try to buy stocks at the right time.

I look for stocks that are building a base (in a sideways consolidation period) with good institutional support. Even better, I try to pinpoint when they break out of a base on heavy volume, as that’s a good sign that professionals are moving into the stock and that there’s a lot more upside left. By sticking to this strategy, I aim to limit my downside risk and capture most of the upward move in the stock.

2. I set guidelines for their eventual sale.

Such parameters may be based on cash-flow projections, dividend-yield theory or some other valuation metric such as price-to-earnings or price-to-book ratios. For example, let’s say you’ve set a $45 target on a stock that’s now trading at $30 and yielding 2%. When the stock hits $45 and yields only a little over 1.3%, do you still want to keep it, or will you move on to something else that offers less downside and a better yield? If you’re using dividend-yield theory (which states that undervalued and overvalued prices can be determined by the dividend yield) for your target prices, you should know at which yield a stock is typically sold by investors and at which yield it is accumulated. I look at both dividend-yield theory projections and cash-flow projections to set my target price on a stock. I also use technical analysis.

3. I plan what I’ll do if my stock starts moving in the wrong direction.

Many professional traders suggest cutting losses at perhaps 8% to 10% of your investment. What’s your strategy for limiting losses? You won’t always be right, so what will you do when you’re wrong? As a value investor, I usually won’t sell a stock simply because it has gone against me at the outset. Value investors typically need a lot of patience, so this strategy might not appeal to you.

A Case Study

I started buying Altria (MO:NYSE) in the spring of 2003 for many of my clients. Back then, it was trading in the low $30s. I continued to add to this position until it reached the low $40s. After a healthy gain in the stock, I recently unloaded it, though a few clients are still hanging on to it. Here’s what happened in my investment process, from start to finish.

In mid-2003, Altria was trading at about eight times forward earnings, and it yielded about 8%. The stock was dirt cheap by my calculations, and it was a blue-chip quality play that had been on my watch list for some time. The stock showed good support in the high $20s and started to move higher on heavy trading in the mid-$30s. It was a great time to buy. The stock was undervalued, according to both the yield and cash-flow projections from Value Line. I liked the technical picture, too.

Value Line had – and still has – a three- to five-year price target of $60 to $90. That’s a very wide range. I felt the stock could get back to $60 within a few years, but at that point, at least according to its long-term chart, the stock would hit resistance. So $60 was a good price target for me.

My intention was to hold Altria for several years and collect the dividends if the stock went nowhere. I obviously didn’t anticipate a quick rally, but it happened. In less than a year, the stock went from about $28 to almost $60 – my original target price.

A few weeks ago, Altria got a downgrade from a major brokerage house, and the stock got hit hard. I wasn’t as concerned with the price as I was with the volume on the decline. On three separate days, Altria fell on volume that was two to four times heavier than the average daily volume for the stock. The first drop on pretty heavy volume was a warning shot. The second decline was an invitation to run for cover. The stock had done what I hoped, so why should I stick around and risk losing profits? It had hit old resistance levels, and big investors who control the stock were exiting. I wasn’t about to hang around and argue with them.

The Dilemma

Altria is still a cheap stock, and that is one reason why I bought it. Today, it trades at about 11 times forward earnings estimates and yields about 5%. Compare that with the S&P 500, which trades for about 18 times forward earnings estimates and yields about 1.5%.

However, Altria is a different beast. Over the past decade, it has almost always traded at a low P/E, and it has yielded much more than the market as a whole. During that period, the stock still experienced extreme fluctuations between the high teens and about $60. Each time it hit $60, it broke down and retreated. And it’s doing so again.

Of course, I don’t know for sure that this pattern will repeat itself right now. Perhaps it will find support right where it is at roughly $54, continue higher and eventually break through the old resistance level of $60. I’m not willing to hang around and see if that happens. Instead, I’ll watch from the sidelines.

Despite the low P/E and relatively good yield, Altria now represents a much riskier play because of the downside risk at these levels. Just as you want to buy a stock that’s just started moving out of a strong base on heavy volume, you should consider selling a stock that’s extended or near resistance when the opposite happens.