Here are two rules for successfully investing in speculative stocks

The odds are against you when you invest in speculative stocks and companies that are not yet making money. Some, if not many, of these companies will never make any money.

A speculative stock is a higher-risk, more aggressive stock with uncertain prospects. Speculative stocks may offer significant returns to investors—but they will also have risk to match.

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Venture capitalism and speculative stocks

Venture capital is a highly specialized business approach, one uniquely suited to the times. It differs drastically from conventional investing, particularly in its uneven results. A venture capital fund may only expect to make money on one in 10 of its investments. However, that one winner may generate enormous profit.

The fund may turn out to be a great investment, even if it only makes money a few years in a decade.

Successful venture capitalists tend to have a record of success in business and in investing. Thanks to their proven ability, they can move quickly when they spot a worthwhile opportunity. Since they raise money from institutions, corporations and wealthy individuals, they can operate within a private company. All this relieves them of a massive amount of legal and regulatory rigmarole fuss that they’d have to go through to raise money from public investors.

Today’s financial industry excels at creating investment products to sell to the public—and just like venture capital investments, perhaps one in 10 of these new products are actually a boon for investors.

Before you buy speculative stocks that claim to have a business plan with Uber-scale potential, ask yourself this: Why would the plan’s creator offer it to individuals, with all the accompanying regulatory burden? In most cases, it’s because they’ve already tried to interest the top venture capital funds, and nobody was buying.

For the same reason, you should also be wary of venture-capital funds that are open to individual investors.

One way to tap into today’s fastest-growing start-ups is indirectly, by investing in companies that are equipped to profit in venture capital as a sideline.

The “sell-half” rule for speculative stocks

Selling half of hot stocks that surge helps you guard your profits. But apply this rule only to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.

Knowing when to sell a stock is one of the most important factors in successful investing—it’s almost as important as knowing when not to sell. That’s why we advise investors to follow a key rule when it comes to rising stocks.

Whether your approach to investing is conservative or aggressive, the quality of your investments matters much more than your skill at selling.

However, you should be quicker to sell aggressive stocks than conservative ones. With stocks we rate as “Speculative” or “Start-up,” it pays to apply our sell-half rule. That’s when you sell half of a stock that doubles in price.

Apply our 5%-10% rule

Every case is different, because each individual has different investment objectives, acceptable risk levels and so on. But you should generally hold on to high-quality stocks, even if they have doubled in price. However, you may want to consider selling part of successful conservative stocks you own if they go way up and come to rise so far they make up too much of your portfolio—say, more than 8% to 10%. In that case, it may make sense to take partial profits.

In investing for our clients, we rarely put much more than 5% of a portfolio into any one stock. But if a stock does so well that it comes to represent 10% of a client’s portfolio, we at least consider selling part of it, to cut the risk. However, every case is different.

You also need to consider your diversification across the five main economic sectors. For instance, if your exposure to the Resources sector is too high, then you may want to sell some of your Resource holdings, to cut risk.

To do that, start by selling any lower-quality Resource stocks you own, while hanging on to high-quality issues.

When you see speculative stocks making money in the market, do you get the desire to buy it or do you look the other way? Share your thoughts with us in the comments.