Cramer used to think about his rules of investing all of the time when he was managing money, but eventually they became second nature to him. He often finds that he digs into his rule archive to answer the many questions people ask him on a daily basis.
A typical question that an investor will ask is what to do with a stock after it has had a hideous decline. The first response that Cramer will give is to ask why they bought the stock in the first place. The purpose of asking that question is to determine if they bought it as an investment or a trade.
If they bought it for investment purposes, that could mean they should buy more. If they bought it for trading purposes, then that means they were waiting for a specific event to occur and should only buy it once. These two concepts should not be intermingled.
"Why does this matter? Because one of my cardinal rules is to never turn a trade into an investment. If there is one concept you must take away from this show, it's that you must never ever trade a trade into an investment," Cramer said.
So don't fool yourself. If you know you purchased something for the purpose of trading, cut your losses quickly when it starts to go awry. Sure, there might be a time here and there where you could turn it into a long-term trade. But most of the time, you'll be on the wrong side of the trade.
However, much to his surprise, Cramer finds that a lot of people aren't prepared when a correction occurs in the market. They are charmed into the market when things are good and then unprepared when things get bad. They assume that a correction means that something is wrong and that stocks shouldn't be touched.
"That is a very big mistake. Corrections happen all of the time after big runs, and they are to be anticipated, but you can't write off the market when they happen," the "Mad Money" host added.
Another mistake that Cramer sees commonly is that many believe they are supposed to be fully invested at all times. He has even met money managers who think they are supposed to have all money invested.
This is complete nonsense!
Having cash on hand when the market corrects is the key to protecting your portfolio. Because sometimes the market will stink and there is nothing to do but just sit in cash.
"In fact one of the chief reasons that I outperformed pretty much every manager in the business during my 14-year run as a professional money manager is that there were substantial blocks of time when I was largely in cash," Cramer said.
Cash is the perfect hedge in an environment when the market hits dangerous highs and could protect from devastating losses.
Cramer considers cash to be the most underrated investment of all. Whenever he sees the market spike, he starts to sell a little and trim here and there to build up a supply of cash. He sells on strength and buys on weakness.
Otherwise, Cramer fears that investors could wind up selling their best stocks just to hang on to their worst stocks because the higher-quality stocks stopped going up—a big mistake.
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