Lottery tickets: this is what I call those investments that involve the greatest measure of volatility, the make-or-break trades that either go “boom” or “bust.” These high-risk lottery tickets can be breathtaking, sweat-inducing, and life-altering; they have the potential to make your day or ruin your life. It all depends on your approach and your emotional self-control: you have to be responsible for the consequences at the end of the day.
First things first: highly speculative trades and investment should only be done with small position sizes. Specifically, I never recommend putting more than 5 to 10 percent of one’s portfolio into speculative trades at any given time. This is what I call being smart speculating: treating your investing like a business and always surviving to trade another day.
Nonetheless, small-scale lotto plays can be highly lucrative as long as you’re willing to follow some basic guidelines (in addition to the small-position-size rule). One of the essential guidelines surrounding lottery-ticket investing is to concentrate on asset classes that haven’t already formed a bubble. When valuations are sky-high, it might be tempting to jump on the bandwagon, but that’s precisely when bull markets give up the ghost.
Thus, even the most speculative lottery tickets should still follow the “buy low, sell high” philosophy of investing. Otherwise, you could end up buying at the top, and after the top always comes the drop. A case in point would be Intel stock, which seemed like a sure thing in the middle of 2000:
Courtesy of barchart.com
But of course (I say “of course” because we all have the benefit of hindsight now) mid-2000 was the worst possible time to get in. The right lotto play would have been to take a long position years earlier, when INTC stock shares were below $20 and the semiconductor business was in its early stages. That’s key to succeeding at this: get in when a sector or a company is still under the radar, and wait patiently for the explosion.
That leads me to the next principle: the longer the base, the higher in space. When a solid, profitable company stays under the radar but you have reason to believe that it will shoot to the moon in due time, your job is to be patient and let a base form on the chart. By “base” I mean a long period of sideways price movement after an upward move.
Markets are known to “consolidate” (take a breather and go sideways for a while after an upward move) because even the best stock can’t just go up all the time. And when a sideways move lasts for a long time, the tension just builds and builds… and when the tension is finally released, it can be quite impressive. Take a glance at this chart of Abbvie stock, which quickly doubled in price after going nowhere for two years:
Courtesy of barchart.com
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This is a prime example of how patience is a virtue in the stock market: while lesser investors would have bailed on ABBV during the long consolidation period, seasoned lottery-ticket players would have seen this as a base forming, preparing for rocket-ship action when the time comes.
Market history has shown that speculation can build wealth, but it requires some big-picture thinking: don’t just look at specific stocks, but also monitor the entire market and be on the lookout for sector rotation. Training your eye and your mind to see which sectors of the economy are in and out of favor can help you immensely in your quest to catch the next big mover.
Let’s take Barrick Gold Corp. as an example: the markets had put selling pressure on gold miners generally at the tail end of 2015. Investors who took note of this, bearing in mind that the mining markets are cyclical and rotations come and go according to a regular rhythm, could have taken a long position in Barrick Gold Corp. stock shares when they were hovering slightly above $6:
Courtesy of barchart.com
When money flowed back into the mining sector, ABX shareholders were undoubtedly delighted to see that their shares had shot up to nearly $23 per share. This is a textbook example of how big-picture thinking goes hand in hand with stock picking for successful speculators.
A final principle for lottery-ticket investing is to take positions in companies that you believe will be a prime target for an acquisition by a large, well-known company. As a general rule, whenever a smaller company gets bought out by a much bigger firm, the stock share price of the smaller company tends to get a nice boost – sometimes a very sizable one.
If you’re worried about your stock shares disappearing if the company is acquired by a bigger one, there’s no need for concern: you’ll most likely either receive a cash settlement for your shares, or end up exchanging your shares of the smaller company for shares of the bigger company that’s acquiring it. Either way, you’re not likely to lose out in this scenario.
A famous example of this phenomenon is when Amazon acquired Whole Foods Market in 2016 and 2017. Finding a similar buyout target requires some serious research and a strong knowledge of the markets, but if you pick the right company, your portfolio could get a nice boost if a merger is announced. But don’t forget the old adage “buy the rumor, sell the news”: the idea is to take a long position before the buyout talks get serious, not afterwards.
All in all, it is entirely possible to be a smart speculator if you’re amenable to some fundamental guidelines. Your best bet is to maintain small positions in great companies with plenty of upside potential – and avoid the hype and hearsay. After you’re acquired some experience as a lottery-ticket investor, you’ll start to get a feel for it and your crystal ball will be that much clearer. Before you know it, you’ll be living the speculator’s dream of big profits from the big movers in the markets.
Chief Editor, CrushTheStreet.com
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