Ever hear of no risk, no reward? Well, buying riskier small cap stocks that could return triple digit gains doesn?t have to be a risky proposition. In the first three articles of this small and micro cap series, the first four rules focused on buying strategies. In this last article, the last and fifth rule will cover selling strategies.
Rule Number Five: Remove emotions from your decisions with disciplined selling strategies.
So now that we?ve covered how to buy in to such stocks, let?s review selling strategies because they are just as important. With selling, always limit your downside with stop losses of 10%-15% in long positions and stop losses of 25% with options. Using this strategy eliminates much of the risk from attempting to capitalize on double digit and triple digit gains. In fact, once you become good at identifying opportunities, having winning pick percentages of 70%-85% would not be unusual. And if you attain these percentages, the 15% of picks you lose several hundred dollars in becomes irrelevant when offset by your huge gains. In reviewing what to do about gains, just abide by one rule.
Don?t get greedy and always lock in gains.
If you don?t get greedy, there is no way you should not make money from a stock that has experienced explosive growth. But this scenario does happen. And only one thing causes this to happen. Greed. People will watch 100% profits turn into 20% losses because of greed.
Just as you did with your buy in price, have a predetermined selling price. As opposed to the buy in price range, I would choose a more specific price. For example, let?s consider stock YYY again and assume you bought the stock for $3 a share. Say you set your goal at $5 a share, a 67% increase, but that it blows right through that price two weeks later.
Now what do you do? Hold on or sell?
With sell strategies of rapidly rising stocks, the picture becomes slightly murkier than with sell strategies of stocks that are falling. When a stock passes through your 15% stop loss order (see part I of this article), it will sell automatically, no questions asked, with all emotions removed from that decision. But what do you do when the stock is shooting skyward with seemingly unlimited upside? It depends on what?s driving the price up. If pure speculation is the only thing driving the price, sell half your position and then put trailing stop losses of 20% on the remaining half. In other words, now that stock YYY has risen to $5 a share from my original buy-in price of $3 a share, I sell half my position, and my stop loss price on the remaining half has now moved up to $4.25 a share. This way I?ve locked in my predetermined 67% gain on half of my position of YYY and the least amount of profit I can make on the remaining half is 42%.
Now if earnings and sales are driving the price up, I may take another strategy. Instead of selling half of my position in YYY, I?ll hold onto my entire position, but again institute a trailing stop loss of 20%, moving my stop loss price-point up to $4.25. This is riskier than the first strategy, but the important thing to note is that I am still locking in gains. In this scenario, I still guarantee myself a 42% gain no matter what happens with the stock from here on out.
The key, and I can?t emphasize this enough, is to always take gains off the table or to lock them in with trailing stops. By doing this, you remove your emotions from your decisions. Formulate a disciplined sell strategy and you?ll make a lot more money than you would by trying to forecast the direction of the small and micro-cap stocks you invest in. Plus you?ll save a lot of money on the psychiatrist you won?t have to hire due to all the unnecessary stress you would have caused yourself by not employing these strategies.
So to summarize, always limit your downside and lock in gains with stop loss orders when investing in small and micro cap stocks and you can invest in stocks with enormous potential without the stress associated with the enormous risk of some of these stocks.