Nobody likes to play by the rules, but with investing, rules can protect you from your own bad judgment, Jim Cramer told his Mad Money viewers Monday night.
Cramer has been saying this market rotation’s hurting stocks that don’t deserve it — and this is a perfect time to explain his rules to help investors actively grow their portfolio.
Cramer said people are always asking him whether he worries about the stocks he owns. The answer is: Of course, absolutely. He said that everyone worries about their investments, especially when your investments are heading lower in an up market.
But that’s why Cramer said he believes in active money management. He said it’s about staying nimble and flexible to always keep your money working for you and not against you. The first step in that process is finding out why your stocks aren’t performing as you expected. Cramer said you need to do your homework, as you can’t be informed if you don’t inform yourself.
Once you know what’s gone awry with your favorite stock, what do you do next? Cramer said investors typically make two mistakes at this point. They end up owning too much stock, so they don’t have any cash left to buy into the decline, or they like all of their stocks equally so have no inclination to sell.
Cramer said investors should always have cash on hand to buy more if that’s what they deem necessary and they should always rank their stocks from best to worst. That way, if your best stock is going down, you automatically know to buy more, but if the worst one is dropping, you can cut your losses early.
Discipline trumps conviction, Cramer concluded. This is the manta all investors should follow. Accept the fact that something may happen that you didn’t foresee and have a plan to deal with it when it does.
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Never Turn a Trade Into an Investment
Never turn a trade into an investment. That was Cramer’s second rule for investors.
Cramer said when you invest for a trade, you’re expecting an event, a catalyst, to take that stock higher over the short term. An investment, on the other hand, is not news driven. It’s something you want to own for the long haul.
How are these two different? Cramer said with a trade, he wants to buy all up front, taking maximum advantage of the event when it occurs, so he can then take his winnings and run.
Investors however, are different. With an investment, Cramer said he buys only a portion up front, buying more on weakness and market pullbacks. Why? Because the ultimate goal is to build a position at the best possible price, and unlike a trade, there’s no hurry.
Cramer said investors should never turn a trade into an investment because if the catalyst they were waiting for doesn’t happen, there’s a good chance that stock is heading lower. The reason is simple: You’re probably not the only one who waiting on the catalyst. Too often, investors make the mistake of doubling down at this point, but Cramer said the odds are against you.
Worry About the Losers, not the Winners
Cramer’s next lesson for viewers was that it only takes one or two losers to wreck a portfolio, which is why good investors always focus more on their losing bets than their winning ones.
Good stocks take care of themselves, Cramer reminded viewers, but how you handle your losers makes all the difference. Take your losses before they become hideous, and don’t buy into the notion that you can sell it “when it comes back,” because it rarely will, and certainly not in the time frame you’re hoping for.
The flip side is also true. You don’t really have a profit until you sell a stock. People often confuse paper gains with the real ones that you can take to the bank. They’re also often reluctant to book a profit because they don’t want to pay taxes on their gains.
Cramer said that gains not taken can quickly become losses that are — and investors need to forget the notion that the market will rally without them and that they’re “missing out” on the action. Stick with your discipline and take some of your profits off the table.
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Repeat After Jim: Corrections Are Healthy
Cramer’s fourth lesson for investors dealt with market corrections. He said that all too often, investors are lulled into the markets during the good times and then they panic during the bad times.
Corrections, he said, are to be expected and are a normal part of a healthy market.
Corrections are actually great opportunities, but only if investors are prepared. Investors that are always fully invested, that is, they don’t have any cash on hand, will never be able to buy more of their winners when the markets put them on sale.
Cramer said that cash is the most under-rated of investments, but when the market is tanking, there’s nothing better.
That’s why he invests by “trading around a position.” That is, selling a percentage into strength, only to buy it back into weakness. By selling into strength, Cramer said investors will always have cash on hand to take advantage of the corrections.
Trading around a position does come with one caveat however: Don’t subsidize your losers with the gains from your winners. Cramer said all too often investors will take gains from their winners to shore up their positions in their losing stocks. But that’s a bad idea, he said, as the losers are likely falling for a reason, while your winners were likely gaining for a reason. Better to stick with the winners.
Focus on Fundamentals, not Hope
Cramer’s last rule for investors was one he repeats often. Investing is not about hope, hope is not part of the equation. Investing is about the fundamentals.
Good investors check their emotions at the door, buying the stocks of companies that have strong fundamentals and avoiding those in decline. If your investment strategy relies on hope to make it work, it most definitely won’t.
Investors also have to be realistic. Not every stock is going to hit a home run, let alone do that the day after you buy it. Most often the stocks of good companies do nothing for a long time before heading higher. This can be extremely frustrating, but some of the best stocks require some sort of incubation period, as good long-term theses take time to fully develop.
There’s no time for “woulda, coulda, shoulda” in investing, Cramer continued. Don’t second-guess your strategy. Keep your head in the game and keep doing your homework at regular intervals. If the fundamentals change, be sure to change right along with them.
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