The Single Most Important Key to Know When You Buy a Canadian Stock

1000% return on investment. 10,000% return on investment. That is what some of the headlines scream of the investment newsletters that cater to the resource or penny stock investor, often traded on a Canadian stock exchange.

This article is not to imply that all Canadian stocks are speculative or are known for wild price fluctuations. What I refer to in this article are primarily the junior resource sector stocks that often are domiciled in Canada.

Those phenomenal returns are indeed possible but usually only happen when one particular event has occurred, and that is when the stock was bought at the right price; often below $1.00 (Canadian dollars in this case.)

Traditionally, stocks priced below $1.00 are referred to as "penny stocks".

These more speculative investments are known for wild price swings. These wild swings can be caused by:

• Euphoria from the speculative nature of the investment
• "Thinly traded" securities, those with low trading volume and therefore low liquidity
• The "seasonality" that the Canadian Stock Exchanges are known for

Buying low is certainly important to get those kinds of returns. One key point, though, I feel towers above all of the rest in importance.

Buy and sell in such a manner as to recover your initial investment as soon as possible.

Then, let the remainder "ride" as long as the underlying story is sound to see if that phenomenal return is ever realized.

A higher than normal percentage of these stocks will eventually become totally worthless! The likelihood is that some may still be in your portfolio when that happens.

Here is what you want to do to protect yourself:

1. Determine what size position you would like in the security
2. Divide that position size into at least three "tranches"
3. Buy only after performing due diligence on the stock and buy only 1/3 of the total position; i.e., the first "tranche"
4. Place limit orders to buy the subsequent tranches at lower prices. Ideally one will be so low as to only get filled when the price collapses on a day of limited liquidity for a desperate seller and you benefit as the buyer
5. Once positioned, sell 1/2 of your position as soon as you realize a double on your investment.

This last point is the key, so I'll say it again:

The single most important key to know when you buy a Canadian stock is to recoup your initial investment when you can by selling 1/2 of your position as soon as you realize a double.

You will now have all of your initial capital back and your maximum loss at that point is zero. The remaining half is now in "free ride" status and eligible for those spectacular returns if the market allows it.

Naturally, you should sell your entire investment at any point that you can no longer sleep at night because of the risk. Also sell if the underlying story on the company changes to where you no longer would want to own the stock.

Never, ever invest money that you cannot afford to lose.

5 Things You Need To Know to Buy Canadian Stocks
Find out more on how to profit buying Canadian stocks.