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Speculation That Will Lose You Money

Monday, 24 Aug 2009 | 8:05 PM ET

Cramer has one explanation of why today’s rally had its legs cut out from under it: Froth, the enemy of good investing.

What the heck does that mean? “It’s all about jumping on what’s the most speculative, the most low-dollar stuff! What’s hottest! What gives you the most jolt,” Cramer explains. With the Dow giving up its rally of over 81 points today, Cramer sees this froth as being the culprit behind stocks dropping back to nearly flat levels today.

Although admittedly a proponent of speculation, Cramer isn’t saying that speculation is a bad thing and he has even sanctioned devoting as much as 20% of your discretionary portfolio to speculation. Notice I said Mad Money portfolio, your discretionary portfolio.

Spectacular?
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So what constitutes froth? Cramer points to the action in Citigroup to lead off the day. Now, you know that he’s been recommending you buy Citi, so what gives? The stock opened up 25 cents and traded to $5 a share and investors were reaching too far, too fast, instead of waiting for better prices. Cramer sees the stock going to it’s book value of $5.75, as most banks trade at the level of cash-on-hand.

”Almost everyone who bought this stock today is hopelessly under water. That's the worst possible place to be and it will most likely cause more weakness tomorrow,” Cramer says.

But this isn’t just a Citigroup story, says Cramer, who points out that you can see the same kind of movement in other low-dollar stocks like Fannie and Freddie on speculation that the housing market will turn. But Cramer thinks this is the kind of speculation that will lose you money. The reason is clear… the future of these companies is UN-clear! For Fannie and Freddie, you still don’t know how much these companies will have to return to the government, there’s little research on them and it’s dangerous to speculate without the complete facts.

These are all symptoms of a frothy market, Cramer says, with people leaping before they look and bidding up stocks that are too radioactive to touch.

Where should you be speculating? Cramer likes Fifth Third Bank , Huntington Bancshares and Regions Financial . Fifth Third Bank is in good shape to do an acquisition, while Huntington and Regions have a lot of room to run, says Cramer. Right now the markets are waiting for hundreds of banks to fail, and the rest who are standing, which Cramer believes to be his picks, will pick up the market share and the good assets from the bad banks. That’s smart speculation, Cramer says, especially on a day when these names got pushed down, allowing you a better entry point for Tuesday.

Cramer likes mobile Internet plays as well, naming RF Micro , TriQuint, ADC Telecom , Tellabs, ON Semiconductor , and Cypress Semi. He thinks they’re all cheap on the basis of the impending “mobile Internet tsunami.” But a company like Level 3 Communications, a dollar play with a bad balance sheet whose stock has been rising, is not a smart speculation.

Cramer’s also a fan of AMD, which just got an upgrade from Citigroup. The company has a giant cash position, good relationship with Hewlett-Packard, a good replacement cycle due to the back-to-school season and fact that it is trading at a 45% discount to the group. Cramer thinks AMD is a perfect speculation.

What’s the bottom line? No company wants their stock to fall down to the dollar levels, and they’re down there for a reason. They at some point were bad, maybe even worthless. Don’t chase everything that is running, Cramer says, and you have to be smart with your speculation.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

Questions, comments, suggestions for the Mad Money website? madcap@cnbc.com

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