How Investors Can Identify the Best Small-Cap Stocks

By: Money_Morning

Sid Riggs writes: Since the October 2014 lows, the Russell 2000 (the broadest measure of the small-cap sector) has gained 18.09%.

To put it mildly, small-caps have absolutely been crushing the broader market over the last four-and-a-half months. Too bad the mainstream financial media would rather spook investors with the "what-ifs" of what is going wrong domestically and abroad.

Speaking of media coverage…

Remember back in September 2014 when the Internet and every major financial network was stumbling all over themselves to spell the end for small-caps because the Russell 2000 had just experienced the dreaded "Death Cross," a technical condition that occurs when the 50-day simple moving average crosses below the 200-day simple moving average?

I wrote an article at that time dissecting the truth behind the small-cap Death Cross.

And the verdict?

A whole bunch of hooey!

Investors who "short" the Russell 2000 during a Death Cross condition experience a dismal 25% winning percentage and an average return of a 0.97% loss.

Bottom line, the Death Cross is statistical a waste of time. It makes for good headlines – and a good way to lose money.

Another Cross Signals Profits

On the other hand, the "Golden Cross" (when the 50-day moving average crosses above the 200-day moving average) actually provides a much more valuable signal.

Investors who "go long" the Russell 2000 during a Golden Cross condition experience an impressive 78.13% winning percentage with an average return of 17.01%.

If you want to dig into those numbers a bit more here's the original article again.

Why am I running on about the Golden Cross? Because the Russell 2000 unceremoniously experienced a Golden Cross back on December 19, 2014 . You probably never heard a single peep about it from the same financial pundits who would rather spook you into reading when the Death Cross occurred.

Since then, the Russell 2000 has hit all-time highs and investors who've been invested in quality small-caps stocks are experiencing some very good returns.

Could we see a pullback (off all-time highs) in the near term?

Recommendations for Small-Caps

Sure, pullbacks are always a possibility.

Longer term, though, quality small-cap companies still represent one of the strongest wealth creation investments in the market – but not just any small-cap company.

It's important to make sure you're investing with global must-have trends that provide strong tail wind. My favorite sectors right now are biotech, cybersecurity, all-flash memory storage, artificial intelligence, and Chinese consumers – all of which either meet a critical demand for the future or are the future.

Already this year, subscribers in my Small-Cap Rocket Alert have pocketed gains of 200% on two separate occasions following two explosive biotech companies.

And things are just heating up.

Last week alone we experienced single-day gains of 27.4% and 9.4% on two non-biotech companies with disruptive technologies of their own that are re-writing how their respective industries operate.

But if investing in individual small-cap companies is something you're not comfortable with yet, here's a way to start.

You can invest in exchange-traded funds that hold several companies with exposure to key sectors. Not only will this give you exposure to key small-cap companies in the growing markets, but it will also lower the company-specific risk associated with investing in individual companies.

Some of my favorite ETFs right now are: PowerShares S&P SmallCap Hlth Cr Ptflo (Nasdaq: PSCH), PureFunds ISE Cyber Security (NYSE Arca: HACK), and Guggenheim China Technology ETF (NYSE Arca: CQQQ).

If you're new to small-cap investing, let's take a moment to talk about risk management.

If you're like me, the idea of uncovering the next Apple Inc. (Nasdaq: AAPL) is very exciting – but as compelling as a company is, it's critically important to make sure you don't bet the farm on any single company – ever!

Most professional traders limit their exposure to individual companies to 2% to 5% of their overall investable capital. Even then, they still typically run trailing stops on each stock in order to keep their overall risk at a minimum while still leaving themselves open to huge returns.

If you really want to make sure you have your risk management in order, limit your total small-cap allocation to no more than 10% over your overall investable capital.

In the 50-40-10 portfolio structure developed by Money Morning's Chief Investment Strategist, Keith Fitz-Gerald, we would refer to these riskier positions as our Rocket Riders, which are great risk-adjusted compliments to your Base Builders (50% of your holdings) and Growth and Income (40% of your holdings).

Source :http://moneymorning.com/2015/03/02/how-to-identify-the-best-small-cap-stocks/

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