Today we are going to talk about one of the most volatile – and often very rewarding — sectors of the market, the small cap biotech/biopharma space. The wide divergence of outcomes in this space is why I take much smaller positions in a bigger pool of attractive plays when investing in the biotech/biopharma sectors. It is something I call “Shotgun Investing”. This area produces many home runs as well as frequent strikeouts.

The upside is that the occasional five or ten bagger will more than make up for the frequent implosions over time if one's portfolio is managed in a prudent and disciplined manner. A perfect example of major returns that can be had in this sector is Avanir Pharmaceuticals (Nasdaq: AVNR) which was one of two inaugural picks in the July edition of Small Cap Gems  when the stock was going for $5.20 a share. Over the past six months the company had positive Phase II trial results for its compound to treat agitation in Alzheimer's patients and then soon thereafter accepted a buyout offer that valued the company at $17.00 a share. A return of more than 200% in just over four months.

Avanir is demonstrative of the returns that can be had when things go right at one of these speculative small cap concerns. More importantly Avanir is a good example of what I look for when making small investments in this speculative and volatile space.

Among the traits I look (and you should, too!) for within this area include:

This is not an exhaustive list but it is a good start. Let's look at two attractive plays in the space that have many of these core traits and could have substantial upside.