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Sell Block: Unhappy Hour

Thursday, 23 Oct 2008 | 7:57 PM ET

Investors who have been watching the market probably noticed the wild fluctuations we've seen recently in the final hour of trading. The Dow's been swinging hundreds of points in either direction in a matter of minutes. The action has had even the biggest minds on Wall Street scratching their heads and wondering, who's doing all the selling?

Hedge funds, Cramer said during Thursday's Mad Money.

The same hedge funds that made huge bets on minerals, oil service, agriculture and other names, borrowing heavily to do it, only to watch those stocks plummet when the market turned down. Soon enough clients started to demand their money back, forcing the hedge funds to sell, sell, sell.

Mad Money Sell Block
Mad Money's Jim Cramer tells you which stocks you ought to be selling right now, either to take profits or to cut your losses.

Now everyday at about 2:45 PM these funds prepare for the following day's redemptions and margin calls, unloading huge positions to raise cash. To offset their losses, hedge funds are shorting the S&P 500. The problem, though, is that the S&P, partially composed of defensive stocks that work during a downturn, is actually going up. So the funds are seeing losses on both their regular stock holdings and their short positions. It seems the only way they can save any kind of face is by flooding the S&P with sell orders to drive the index down. The move makes hedge funds' performance look a bit better at the end of the day.

The rebound rallies that follow these sell-offs happen, Cramer said, because even a small number of buyers can move the market when the trading volume is so low.

The real culprits here, as far as Cramer sees it, are "funds of funds." These are the middlemen in the hedge fund world that invest client money into other hedge funds for a fee. Unlike regular hedge funds, funds of funds have no lock-up agreement, meaning clients can get their money back at any time, so this puts added strain on the hedge funds in which they invest. Any time a specific hedge fund starts to decline, these funds of funds cash out. This trend has been a big part of the forced selling we've seen lately.

As long as this selling continues, we won't find a market bottom, Cramer said. For that to happen, all the remaining sellers would have to unload their positions. The only people left in the market by then are those that never sell no matter what, let alone look at their 401(k)s, and "we're not even close to that point" yet, Cramer said.

That could change once October performance statements are out. Regular investors might panic, pull their money out of mutual funds, forcing still more selling, and maybe, finally, putting a floor under this misery.

In the meantime, stick with Cramer's suggested defensive plays and his recommended high-yielders. And be ready to feel some pain. It could happen. But consider buying as the market comes down.


Questions for Cramer? madmoney@cnbc.com

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