Mad Money

Cramer: Trading vs. Investing—Know the difference!

Cramer: How to handle your stocks in a decline
Cramer: How to handle your stocks in a decline

Jim Cramer sees a lot of investors freaking out when the market drops, which is why he has taken the time to reveal his top tricks to managing the damage to a portfolio during a decline. His tricks simply come down to one word—discipline.

While having rules in place is certainly not fun when it prevents you from making boatloads of money when the market is high, Cramer knows that it pays off in the long run by controlling the damage to your portfolio when the averages take a nosedive.

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.

Why does he ask that? Because one of his cardinal rules is to never turn a trade into an investment. If there is one thing he wants investors to take away from "Mad Money," it is to never confuse these two concepts.

That means understanding the purpose of why you are buying a stock.

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If you bought it for investment purposes, that could mean you should buy more. If you bought it for trading purposes, then that means they were waiting for a specific event to occur and should only buy it once.

Cramer has seen that the vast majority of investors buy a stock for one reason, and then another reason happens. So then they decide to turn the trade into an investment, and buy more as the stock goes down. Or perhaps the reason for the trade never happens, so you end up holding the stock.

"What's the worst thing that can happen? The answer, of course, is plenty, and almost all of it bad," Cramer said.

When Cramer wants to invest in a company, he will buy a small amount of it to start and then hope that the stock market will knock it down so that he can buy more at a better price. He loves a good market-wide correction to get a better price on buys.

Read more from Mad Money with Jim Cramer:

Cramer: How to detect phoney-baloney market moves
Cramer: Cash in on stocks due for a bounce
Cramer: The best entry & exit point for stocks

Trading is exactly the opposite. He puts the maximum on at the beginning, because he believes that the data point or event is about to occur. He will never buy anything for a trade without a defined catalyst, and he will never just hope it goes higher. There can be no hope in the equation when you buy a stock for a trade.

"I buy down when I am investing. I cut my losses immediately when I am trading if the reason I am trading the stock doesn't pan out," the "Mad Money" host 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.

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