Mad Money

Stop-loss orders: Helpful or harmful?

Cramer's Playbook: Stop loss not for everyone
Cramer's Playbook: Stop loss not for everyone

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

Individual investors often ask Jim Cramer if they should use stop-loss orders to protect against a major selloff.

"Stop-loss orders let you automatically sell a stock once it drops below a certain level," Cramer explained.

And although Cramer believes stop-loss orders can be a great tool for professional traders, he doesn't like them for individual investors.

That's because he doesn't advocate individual investors trade the market. Stop-loss orders are for pros who move in and out positions; they allow pros to mitigate short-term losses.

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But Cramer doesn't want individual investors to get preoccupied with short-term moves; either higher or lower. They can obscure the big picture.

Instead the "Mad Money" host wants individuals to focus on the long-term, by putting money to work in the stocks of good companies with solid balance sheets, thoughtful management, promising opportunities and strong profit margins.

Those are the kinds of stocks that Cramer believes should generate sizable returns that outperform the market over time.

"That's how I want you to think," Cramer said. "I will never root for you to lose money. However, thinking about a selloff only in terms of how much money you could lose is very short-sighted."

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That's not to say Cramer doesn't advocate actively managing your portfolio. During a selloff, Cramer recommends stepping back and identifying the catalysts behind the decline. If those catalysts change the thesis for owning your stock, then he suggests scaling out.

But he doesn't want you to get taken out of a stock, by a stop-loss order, simply because of a decline. That ignores the underlying thesis for owning a stock. "It's not how I want you to invest," Cramer said.

Call Cramer: 1-800-743-CNBC

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