Big Game or Small, Here's How to Go About Stalking a Trade

My favorite piece of trading advice comes from George Soros, who said, "I'm only rich because I know when I'm wrong. It's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong."

Stanley Druckenmiller, one of the best investors in the world, has often referred to this advice when he talks about his success, and I believe it is the heart and soul of what traders must do to produce exceptional returns.

While the advice is obviously very effective, actually implementing it can be tremendously difficult. How do you keep losses as small as possible but stay highly aggressive when you feel you have a big winner? How do you know when it is time to be aggressive or to cut and run? If you can determine those things with some degree of precision, you are sure to do well.

The only way your stock is a big winner or a pathetic loser is through constant vigilance. I compare the process to stalking. In the words of the band The Police, "Every move you make, every step you take. I'll be watching you." You need to learn everything about that stock and then watch the way it moves and acts.

The first step in any trade or investment is identifying a good idea. For many market participants, that is the start of the process but the end of it. They buy the stock, read about it once in a while, and take no further action. They hope and pray it turns into a winner. Sometimes it does, but quite often it doesn't. Is it any mystery why that approach doesn't consistently produce big returns?

Picking a good stock is the first step, but it isn't nearly as important as the follow-up.

You really don't know a stock until you closely follow its price action. How does it act in poor market conditions? What news flow is impacting it? Is it in the right sector? Is it worthy of your love, or should you cut your losses and move on to the next opportunity?

You won't know if a stock has the potential to be a big winner until you follow it closely for a while. Over time, you are going to learn more about fundamentals and how market conditions impact them. Picking a small-cap stock in a market that doesn't favor small caps is one recent warning signal that keeps occurring.

There are a number of stocks that I discuss in my column that I have followed for a long time that I think are starting to look more promising. I've watched both the AdvisorShares Pure US Cannabis ETF  MSOS and Xeris Biopharma Holdings  XERS for years. I understand their price action and the news flow that is going to impact them.

My approach with these stocks is to constantly trade them in very short time frames.

My position size will vary constantly as they move around. I want to always be in the position of being able to take advantage of pullbacks while I await news catalysts. I'll reduce some into strength when I have a chance and reload when I see support. The goal is to ramp up position size substantially only when it looks like the catalysts will occur and bring in new buyers.

In almost all cases, my initial buys are very small, leaving plenty of room to increase the position as it develops. The longer the time frame of the investment, the more short-term trading I do to adjust my position.

Stalking a stock is all about adjusting position size as you learn more about the situation. I want to take advantage of short-term volatility and be sure that I have bigger positions as the price action improves. It is an ongoing process and is the complete opposite of the one buy and one sell approach that is what we hear about most often on Wall Street.

If you want to follow Soros' advice and be quick to admit when you are wrong but be aggressive when you seem to be right, then the best approach is to stalk that stock. Watch every move it makes, learn its personality, know what upcoming events are going to impact it, and always be ready to move quickly.

At the time of publication, James "Rev Shark" DePorre had no position in the securities mentioned.