When markets are riddled with volatility, tried-and-true actions can help investors boost their chances for long-term success.
Step No. 1 – Have Stop Losses in Place
All of a sudden, your favorite small cap stock is falling out of the sky.
What do you do? Do you sell? Do you hold?
Or, do you freeze, becoming nothing more than a nervous, emotional trader that sells because everybody else is? Unfortunately, most of us freeze, too scared to think straight.
We get caught up in the mad rush of herd mentality.
Instead of calmly looking into why a stock may be falling (sometimes for no reason), we slowly lose our minds and sell. But that’s the wrong way to trade.
One of those plans must involve what’s known as the trailing stop loss – the very exit strategy that removes all emotion from the trade. If your stop is hit, you’re out automatically. There’s no second-guessing. If your stock pushes higher, the trailing stop resets higher, too, never triggering until it plummets.
For example, let’s say that in the middle of January 2019, I risked $10,000 on a small cap stock that trades at $10. When the stock reaches $16, I’m sitting on good money. All of a sudden, the stock starts to fall to $11 because run is ending, and as others panic on the pullback.
What to do? Panic and sell like a fool?
Or protect the gains I have without emotion?
I’d choose the latter with a -10% trailing stop, for example, which means if the stock now pulls back 10% from current prices, I’m automatically stopped out, no questions asked.
Step No. 2 – Have a Plan
Have a complete 360-degree view of what you’re buying before you buy it. Fundamentally, take a look at what’s under the hood of the company with regards to earnings ratios. Technically, understand what’s happening in the short- and long-term with support and resistance.
Know your exit strategy, and your money management strategy, including stop losses and trailing stop losses. Never risk money you cannot afford to lose. Keep your expectations in check, be realistic. And above all else, never risk more than you can afford to lose.
Step No. 3 — Know Where the Best Profit Opportunities Are
I tend to search for investment ideas in small-cap stocks.
That’s because most are insulated from geopolitical issues, such as trade war fears. Remember, small caps have much less exposure to international headaches than companies in the S&P 500.
Even better, small-cap stocks have a history of outperforming large-caps, returning an average gain of 12% a year over the last 90 years, as compared to a 10% annualized gain on the S&P 500, as reported by Market Watch.
And, according to Smart Asset:
“Between 1979 and 2015, small-cap stocks in the Russell 2000 index outperformed large-cap stocks in the S&P 500 20 times within 37 years. In terms of the average annual return on investment, small- and large-cap companies’ stocks were virtually neck and neck, with the S&P 500 paying investors back 11.7% annually versus the 10.3% annual returns generated by the Russell 2000 index. In the long run, investing in smaller cap stocks may be just as profitable (if not more profitable) than investing in larger ones.”