Mad Money

How to Cut Losses in a Sell-Off

Stocks on sale are great, but the first priority in any sell-off is minimizing losses, Cramer said. Here’s how he recommended doing it:

Before a correction even happens, every stock in your portfolio, as well as the stocks you’re seriously considering buying, should be listed and assigned a one, two, three or four in descending order of conviction.

The ones are your favorite stocks, the ones you’re willing to buy more of at current prices. Twos are stocks you’d buy if they dipped in price just a bit, maybe 5% to 7%, Cramer said. Threes are stocks you’re waiting to sell if they climb 5% to 7%. Fours are stocks you want to sell right away.

Cramer recommends revisiting this list every Friday after the market closes. Never rank during the trading day, he said. You want to be settled and able to objectively evaluate your holdings.

In a normal market, ones are buys, fours are sells and twos and threes are holds until the right opportunity presents itself. But during a sell-off the ratings change. Twos can become ones, and fours can become threes. But just because the share price dropped doesn’t mean a stock is necessarily cheaper. And you don’t want to sell nothing while buying more of everything, Cramer said.

This is why Cramer tells Homegamers to “circle the wagons.” It’s a call for investors to get picky about what they own and want to buy. Circling the wagons means dumping your threes and fours. Doing so puts you in better shape than if you tried to tough out the sell-off with these stocks. Sooner of later, everyone panics and sells the threes and fours at the worst possible time, Cramer said. So don’t wait for the worst time.

Getting rid of the threes and fours gives you the capital needed to buy more ones and twos, which is where you have your most conviction. And that conviction should keep you from getting panicked out of the market.

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