Trading Junior stocks and small caps

I allocate about 20% of my portfolio to junior stocks and small caps ( below $5 ) .

Many of them do not have options available. If there are options, it is usually illiquid and has wide spreads.

But juniors can give you handsome rewards especially if you have some access to some good fundamentals on the company. For precious metal juniors, it could be deposits, strong management and a potential rise in the metal prices. I got most of my ideas for junior precious metal stocks by attending the Vancouver Gold conference which is held twice annually. Here I have the opportunities to hear presentations and talk to the companies on exhibition. The fundamentals could be a superior product, service, business models, confirmed contracts and rising from a very low base out of bankruptcy.

I have been trading juniors for more than 5 years. It is almost impossible to time the entry technically. It is a also difficult to use stop losses because the spreads are so wide.

So I use the following strategies.

First the stocks must be on a fundamental growth potential. It is very important that the companies must have cash to sustain for at least 2 years. Sound, prudent and experienced management is also key to their success. It is very similar to investing in a start-ups which was part of my business experience. The risks are high. Success rate could be 1 in 100. With due diligence you may be able to improve the ratio.

Next, I just buy a basket of stocks with the allocated 20% of my portfolio. These are companies I believe to have huge potentials. I re-balance it 2-3 times a year by selling the losers and add in more winners. For companies which have increased > 100%, I consider selling 50% and effectively you get a free trade for it to reach maximum potentials. If I believe the fundamentals have change for a particular company, I will sell the stock even though the losses could be high. Poor fundamentals could be product failures, market change, poor drilling results and management change.

These strategies have worked well for me. Roughly, 25% of the companies in this basket lose about 80% of its value after a few years. Some companies even go to zero. Usually, I am able to salvage some residual values. But, there are at least another 30% that gives me multi baggers. Some of biggest gains give me returns of 4-5X gains and I am still holding on to it. The rest seems to go nowhere and is stuck in a range.

Many times, even the multi baggers go through wild volatility .In 2008, some of the juniors went to <30% of its original price. But I kept the stocks because fundamentals were intact. I was not shaken because my exposure is <20% of my portfolio. For some stocks that I really like, I bought more stocks and average down my entry price. During 2009 boom, many of them went up 6-10X.

I have gone through 2 cycles of boom and bust for these stocks over the last 6-7 years. Overall, the portfolio make good average annual returns of >30% without the stress of managing it day by day.