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Cramer: Understand the risk in this market

(Click for video linked to a searchable transcript of this Mad Money segment)

Jim Cramer worries too many investors don't understand the risk they're facing in the stock market, right now.

The issue really hit home for Cramer as he pondered a headline in The Wall Street Journal that read "Investors Struggle to Digest Fresh Fears."

"It took my breath away," Cramer said.

Therefore, with the S&P 500 and Dow Jones industrial average within a stone's throw of all-time highs, Cramer thinks now is a good time to examine risk and how serious any forthcoming downdraft might be.

Adam Jeffery | CNBC

Of all the risks ever facing investors, Cramer says nothing is more serious than systemic risk. "It must be avoided at all costs," he said. Systemic risk surfaced in the 1930's and again in 2008, when developments called the viability of the entire banking system into question. "Systemic risk can wipe out vast swatches of wealth."

In the event of systemic risk, investors should go to cash. Cramer, however, doesn't believe investors are facing anything nearly so serious.

Another big risk involves the mechanics of the market. "The risk that high frequency traders pose to the market is always there and it hasn't been fixed. Another flash crash could happen at any time. There are still many unregulated pools and untested circuit breakers," he said.

Although Cramer believes this kind of risk always looms, as he's said so often, he believes the best way to mitigate the risk is to hold stocks of high quality companies, with impressive management teams, strong financials, and solid prospects for the long term. If you do the homework and believe in your holdings, he says, whatever high frequency trading does to the market won't matter to you.

With systemic issues and market mechanics not posing any immediate threats, Cramer thinks it's important to understand what is, in fact, posing a threat.

And that's Iraq.

"It's certainly possible Iraq's oilfields get shut down," Cramer said. "I said last week that there have been several bear markets caused by Iraq and a spike in oil, so it's perfectly reasonable for our market to drop 2, 3 or even 5 percent, near term, if the price of crude jumps 10 percent."

But other than Iraq, Cramer just doesn't see any problems that are so serious they can derail the market altogether. Conversely, he believes earnings and M&A may provide positive catalysts.

Therefore, to position your portfolio as if the market is facing systemic risk or some kind of technical failure seems excessive to Cramer.

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Should you be cautious? Of course. Higher oil prices could trigger a big pullback; they could potentially lead to a correction.

But Cramer thinks, as circumstances stand now, that's likely the worst of it.

He doesn't expect the market to return to levels witnessed a few years ago, when stocks were taken down to generational lows. "Of course, I am mindful. I am not being blind to risk. I'm simply trying to understand the risk. But I also know that if it doesn't get worse, the fear can get digested and stocks can again rally."




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