Why It’s Important to Have Strict Risk Controls

It’s quite a market out there. There’s a lot of volatility, no particular direction, and investor sentiment remains decidedly negative.

Back in June, I wrote in this column about an innovative small company called AuthenTec, Inc. (NASDAQ/AUTH). This stock, which looked very promising, just got walloped after surprising the market with reduced guidance.

AuthenTec is in the business of selling fingerprint authentication sensors and chips to the PC, wireless device and security access control markets.

The company’s technology allows fingerprints to be read below the surface of the skin down to what is known as the “live layer.” Apparently, this is your true fingerprint. The company’s products can accurately read your true fingerprint (which is unique) under virtually all circumstances (like outside in a blizzard).

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AuthenTec sells its products to big-name customers like Fujitsu, HP, Hitachi, HTC, Lenovo, LG Electronics, Samsung, and Toshiba. One of the company’s main customers, however, just told the company that it did not plan to renew its use of AuthenTec’s technology in their PCs. This customer represented a significant amount of AuthenTec’s total sales and the company had to issue a press release with revised guidance.

Once the news hit the Street, the stock sold off immediately, and now it’s trading in penny stock territory. This kind of story happens all the time, particularly in the small-cap sector of the market.

This is why I find it so important to have strict risk controls when you’re speculating in companies like this. The fact of the matter is that, as a stock market speculator, you have to be prepared for anything — hurricanes, the loss of a major customer, new government regulations, the death of a CEO, etc.

Being successful at speculating in stocks isn’t easy. If it were, there would be a lot more retired investors in your neighborhood. As a player, you’re going to win some and you’re going to lose some. The key is to make the most when you win, lose the least when you lose, and always have enough left over to keep playing the game.