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Big Rewards vs. Big Risks

Friday, 15 Feb 2013 | 6:00 PM ET
Speculate the Right Way
In discussing ways in which to keep your portfolio diversified, Mad Money host Jim Cramer recommends owning a speculative stock. However, speculating the wrong way can have you swimming in losses, he says.

Jim Cramer always talks about investing in spec stocks. But what exactly does he mean?

These are stocks that present higher risk but also offer higher reward.

That may sound a little surprising from Jim Cramer, after all every night on CNBC's "Mad Money" he always says, "some people want to make friends. I just want to make you some money."

When compared to Cramer's other strategies such as dividend yielders and growth stocks, a higher risk stock hardly seems to make sense.

"I realize this is the exact opposite of everything you've ever been told," said Cramer.

And that's the point.

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"The fact is, a lot of people end up investing poorly because they aren't engaged, they find the whole process boring and they don't stay on top of what they own," Cramer said.

"If you neglect your stocks, if you don't have the motivation to do the homework, then you probably won't do too well either because success mandates active investing."

And that begs the question — how do you pick a spec stock that's right for you?

Vito Palmisano | Photographers Collection | Getty Images

Cramer said the overall goal is to invest in tiny, largely unknown companies in sectors that could catch a turnaround. That way, as Wall Street warms to the company, you will benefit from the gains.

One way to identify these stocks is to look for companies that trade in the single digits.

"Typically, two kinds of stocks trade in single digit territory, the hated, broken stocks of troubled companies that have been abandoned and left for dead by the big institutional money managers. And the relatively unknown stocks of undiscovered companies."

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Read More from Cramer:
The Right Price: Cramer's Buy Strategy
5 Things That Should Be in Your Portfolio, Now
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Also Cramer advocates looking around and trying to spot a short-term trend in its infancy. However, there is a caveat. "These speculative fads happen quickly and don't often last long," said Cramer.

Another area in which Cramer likes to speculate is biopharma — looking for companies that could have the a blockbuster drug in their pipeline.

(Read More: Cramer's Intriguing Speculative Stock Play)

Of course there are many other spec plays in the market but no matter which you choose, Cramer said one thing always remains the same.

When you speculate don't buy and hold forever. Instead, you must do constant homework and after the company generates gains that meet your criteria, ring the register.

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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

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