Maintain Stop/Loss Limits in a Speculative Buy

A company we talked about last year, Distributed Energy Systems Corp. (NASDAQ/DESC) just came out with financial results that weren’t very good. The company is trying its best, but, as it turns out, the alternative energy industry is still a risky market sector in which to operate.

We first mentioned this company in July of last year and the stock doubled to over $10 per share, partially due to the company’s own growth and partially due to the stock market’s enthusiasm for alternative energy stocks.

Jim Cramer even said the stock was a “buy” on his popular show “Mad Money.” What’s happening now is a big dose of reality.

The company makes great products, but its order flow isn’t all that even. Volatile natural gas prices are also affecting the timing of new sales orders at the company’s Northern Power subsidiary. When the company reported its latest financial results, the stock dropped a solid 25% in one day.

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So, what does this example serve to illustrate? Well, many things in fact. First, make no mistake about it, stock market investing is a risky business. I prefer to call it speculating rather than investing. There’s no getting around the fact that investment risk is very high when dealing with equity securities.

Second, it is vitally important to maintain stop/loss limits on speculative stocks, not only to preserve the profits from your winning positions, but also to help cut your losses on losing positions. Even if the stop/loss limits are informal, they are critical in helping you manage investment risk in your portfolio.

Finally, the Distributed Energy Systems story serves to illustrate that all things change. A market darling one day can easily be a big loser the next day. In this particular case, the company offers great products, but it can’t control the order environment from its customers. Volatility in new sales is very real and this is why the stock is a rollercoaster.

So, we know for a fact that stock market speculating is a very risky venture. We know it’s critical to maintain stop/loss limits on all equity positions. And we know that fundamental change happens very quickly, particularly with smaller companies. Now, all that’s necessary is to apply this information to your own advantage.