Given the tremendous potential of the cannabis industry, it’s natural for investors to be attracted to marijuana stocks.

Investors have stars in their eyes. My inbox is flooded with offers to make me a marijuana multimillionaire. Age-old “pump-and-dump” schemes are in full bloom in marijuana stocks. The headline of this article is a borrowed one; my only contribution is the word “carefully.”

Let’s explore this topic with the help of a chart. Eleven points to potentially make millions will follow.

Chart

Please click here for an annotated chart of analysis of marijuana stock Canopy Growth CGC, -0.70% . I have picked Canopy Growth because it is the biggest marijuana stock.

• The chart shows the sell signal given by The Arora Report in June right at the prior peak. Subsequently the stock lost more than one-third of its value.

• Canopy Growth reported earnings below the consensus, and significantly below the whisper, numbers. Stocks move based on the difference between reported earnings and projections compared to the whisper numbers. Canopy Growth was well on its way to lose one-half of its value from the peak when the news came of a major investment in the company. Constellation Brands, STZ, -0.02% , known for its Corona beer, invested about $4 billion, paying a whopping premium of 51.2%.

• The chart shows the heavy volume and move in the stock on the news. An “up” move on heavy volume is considered positive.

• The chart shows The Arora Report signal to buy Canopy Growth. When The Arora Report gives a buy signal, it simultaneously gives a target zone.

• As shown on the chart, the top band of the target zone was $40 at the time of the buy signal and subsequently was raised to $50.

• When Canopy Growth’s stock price went over the price paid by Constellation Brands, The Arora Report gave a signal to take partial profits on a 10% tranche and raise stops on some quantity to protect profits.

• It is important to note Arora’s Second Law of Investing: “No one knows with certainty what is going to happen next.” The best that investors can do is make decisions based on probabilities. The probability was high that Canopy Growth stock would back off after it became more expensive than the value that Constellation Brand put on it. However, there was also a high probability of rumors of takeovers emerging at that time. For this reason, partial profits were taken only on a 10% tranche.

• As we anticipated, the rumors caused a further runup in the stock. The latest rumor was that Diageo DEO, +0.46% , the maker of Smirnoff and Johnnie Walker, was in talks with at least three Canadian cannabis companies.

• The rumors caused a big jump in marijuana stocks, including Aurora Cannabis US:ACBFF, Aphria US:APHQF, Cronos Group CRON, -0.97% , Tilray TLRY, +0.84% , Neptune Technologies NEPT, -0.46% and marijuana ETF MJ, +0.48% .

• Momentum (momo) crowd money flows have been extremely positive in Cronos Group. Cronos Group also saw a short squeeze that was more intense than in other stocks in the group.

• Professional-investor (smart money) flows show selling into the strength. Segmented money flows provide investors an edge. Smart money flows were a major contributor to The Arora Report’s accurate signal to sell Canopy Growth at the previous peak. We provide segmented money flows on 12 cannabis stocks. To learn more, please read “11 marijuana stocks’ money flows show which are investor favorites.”

• As a group, these stocks do not move with the Dow Jones Industrial Average DJIA, +1.33% , S&P 500 SPX, +1.59% and Nasdaq 100 NDX, +2.33% . This can provide important diversification.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

How to make millions

The observations above lead to the following 11 pointers about making millions in marijuana stocks.

• Expect these stocks to be very volatile.

• Investors may want to take advantage of the volatility by selling into the strength and buying into the weakness.

• Those with a long-term horizon can use the technique of trade-around positions that we have been successfully using to often double returns. The concept is to accumulate core positions on significant weakness and then trade around those core positions with shorter time frames.

• The most important pointer is to not fall victim to “pump and dump” schemes. In such schemes, certain stocks are heavily promoted. The stocks run up on the promotions. Those promoting the stocks buy them before they start pumping and then dump them when mom and pop start buying them.

• Be especially careful about investing in offers via emails that promise quick riches.

• The path to making significant profits in cannabis stocks is most likely to be a difficult and torturous one requiring significant skill and proper guidance. Investors are likely to be better off to acquire such skills and seek the proper guidance before committing their hard-earned dollars to cannabis stocks.

• Please note that on a fundamental basis, there is no way to justify the present valuations. Even under the most optimistic scenarios, according to the Quantitative Screen of The ZYX Change Method, we have difficulty coming up with valuations higher than 20%-50% of where these stocks are trading now. Please click here to learn about the Quantitative Screen of The ZYX Change Method.

• Most money is likely to be made in smaller stocks, but at the same time most money is likely to be lost in smaller stocks. Investors will need a proper balance between larger stocks and smaller stocks.

• Investors should take advantage of opportunities to diversify in this space. One example is to diversify into stocks such as Zogenix ZGNX, -1.46% , GW Pharmaceuticals GWPH, +1.97% , Zynerba Pharmaceuticals ZYNE, +1.54% and Scotts Miracle-Gro SMG, +1.46% by scaling in on significant pullbacks.

• Watch out for newsletters recommending marijuana stocks, as many of them are not independent but are paid by marijuana companies. Their interest is not the same as yours. Investors may want to stay away from newsletters with conflicts of interest either directly or indirectly through advertising.

• Do not put all or most of your eggs in marijuana stocks. Prudence calls for a well-diversified portfolio across various industries, geographical regions and asset classes. Also consider holding significant amounts of cash as the market is very high and can pull back.

Dump pumped-up stocks

There will be plenty of opportunities to make money by dumping pumped-up marijuana stocks by short-selling them. In short-selling, money is made by the price of the stock going down. As a note of caution, short-selling is suitable only for experienced investors, and stops should always be used.

This column provides a starting point for your research. Every investor must do their own further due-diligence research before investing.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.