Just last week, I wrote about one of the hottest stocks on the Street. As it happens, this company operates in one of my favorite industries for investment–the solar energy industry.
DayStar Technologies (NASDAQ/SC/DSTI) is a hot stock in this market, trading well over one million shares a day–and the company has no material revenues! The stock has already bolted about two points higher since the time of last week’s column. DSTI is a trader’s dream stock, and, so far, it’s making a lot of speculators rich.
Of course, this is what it’s all about–speculation. Of course, speculation means only one thing–risk. So really, risk is what it’s all about. Risk, a four letter word that is way more important than potential return when you’re choosing a stock.
I’ve always contended that risk is a more important variable than potential return. Here’s why: If you approach stock market investing by focusing on risk instead of potential returns you will be much better off over the long haul because you will be able to preserve more capital.
Naturally, if you are willing to take on big risks, you can make some big money from the stock market–of course, you can lose a lot of money with these stocks, too. This applies particularly to those stocks that are experiencing a lot of momentum; stocks like DayStar Technologies. With momentum trading, you’ve got to be very careful to make sure that you don’t get caught when the market action turns. Make no mistake; the market action always does turn, eventually.
If you are engaging in short-term trading or momentum investing, it is crucial that you maintain tight stop-loss limits to protect your capital. If you’re trading DayStar Technologies, for example, you might consider a tight 3% or 5% stop-loss limit from your entry price. This way, if the market turns against you, you can get out with only a modest loss.
Alternatively, if you already have a winning position, you also need to maintain a moving stop-loss limit from the stock’s most recent price. This way, if the stock moves lower in a sustained move, you won’t give up all of your capital gains.
Every business and every stock has a cycle. If you view your stocks in terms of investment risk, instead of potential return, your portfolio will most definitely thank you for it.