In Wednesday’s column we discussed the current volatility in the market as well as the high beta areas within equities such as the high-flying biotech sector. Emphasis around this sector was placed on why it is important to have 50% to 75% of one’s biotech portfolio in the large cap growth stocks of the sector depending on the individual investor’s risk tolerances. This will lower the overall volatility of the portfolio and allow one to navigate through these market hiccups that occasionally bring substantial moves to this sector.

In today’s column, we will discuss the small cap area of the biotech sector which is inherently more volatile than the large cap part of the sector. It is also a space that frequently yields “home runs” when things fall right and “strike outs” when trials do not turn out as expected such as the collapse in the stock of once promising Tetraphase Pharmaceuticals (NASDAQ: TTPH) which lost almost 80% of its value last Wednesday once it was announced its main drug candidate flunked a late-stage trial.

This is why investors should employ a few core strategies in the small cap biotech sector. First, it pays to take small stakes in a myriad of speculative but promising small cap companies in this lucrative space. I have long dubbed this “Shotgun Investing” within the biotech sector. These companies should have multiple “shots on goal”, promising pipelines, strong balance sheets, and whenever possible partnerships or collaboration deals with larger players in the biotech/biopharma industry. Investors should get comfortable knowing that it doesn’t matter how good their analytical skills are, they are still going to have the occasional blow up as drug development is just inherently risky. This will be more than made up for over time by the occasional grand slam when a lucrative drug candidate successfully navigates the approval process and/or your small cap company is bought out for a substantial premium by a larger player in the sector.