Cramer's Investment Rules Can Help Take The Complexity Out of Trading
I’ve never been a Jim Cramer fan. My early investing education was focused more on Ben Graham and Warren Buffet, so Cramer always struck me as a loud mouth, blow hard. For those of you familiar with Graham’s book, The Intelligent Investor, I had always thought of Cramer as Mr. Market’s obnoxious page boy.
It is perhaps a shame, because I had over looked his book, Real Money, up until recently. In this book, Cramer does a good job of explaining where he isn’t really as speculative as he is often touted as being. In fact, I think it was this book that got him a lot of media attention (both mainstream and on the blogosphere) for recommending index funds. Of course, he didn’t say index investing should replace active investing as many have implied. Rather, he recommends index investing for those who either can’t fathom stock investing or choose not to expend the time and effort required to do so successfully. In fact, it’s the same position Warren Buffet has stated.
So, Cramer’s not as much of an idiot as I once thought. As proof, I offer the following list of rules based on Cramer’s 25 Investment Rules.
1. Bulls and bears make money. Pigs get slaughtered.
Don’t be greedy. We’ve all seen recently just how greed can come back to get you. But this rule also hints at another truism – you don’t need the market to go up to make money.
2. It’s OK to pay the taxes.
Many people fail to lock in a gain, simply because they don’t want to incur a tax hit. This is silly since, even at a 35% tax rate, you still have a 65% profit! Conversely, if you don’t take a profit – you’ll lose a lot more than taxes.
3. Don’t buy all at once.
Timing the market is a nearly impossible feat, so don’t try it. It’s a sucker’s game. Buy incrementally. Take your total investable cash allocation, and split it into thirds. Pick 3 price points for a given stock, and Invest 1/3 at a time, on the way down.
4. Look for broken stocks, not broken companies.
Bad companies with good stocks are no bargain, good companies with bad stocks are bargains. As much as he claims that stocks are just pieces of paper, they really aren’t in the long term. Look for solid companies that have been beaten down unfairly, or temporarily, in the stock market. Avoid stocks that are simply trading on excitement or momentum, with little to hold them up.
5. Diversification is the only free lunch.
big bets and performance chasing WILL catch up with you. Diversification is absolutely essential, as this past decade has shown.
6. Buy and homework – not buy and hold.
Don’t simply buy a good stock in a good company and forget about. Index investing is for the “set it and forget it” approach. Active investing requires you to be diligent and watch your holdings. Analyze the company, the filings, check the website and conference calls. If you can’t do the homework, buy and index fund.
7. No one ever made a dime panicking.
Be disciplined. Have a plan and stick to it. Just be sure your plan accounts for the negative possibilities so you won’t feel the need to panic.
8. Own the best of breed.
Buy the INTELs, not the AMDs. Just because it’s cheaper, doesn’t make it better. When times turn tough, the superior companies will survivor or even prosper.
9. He who defends everything, defends nothing.
Discipline trumps conviction. Know which stocks you are willing to sell in case you need to sell. Rank your stocks. Don’t try to buy every stock you like, because you will be opening up too many positions to manage (defend).
10. Fundamentals must be good in takeovers.
Buy under valued good companies that are doing well. Don’t speculate in takeovers. If the under valued, good company who’s stock you own is acquired in takeover, then so much the better.
11. Don’t own too many stocks.
If you own too many, you are your own mutual fund. You can’t manage that many stocks. Cramer recommends 5-10 stocks – just enough for diversification, not distraction. I’ve seen many studies that state you can get proper diversification in a few as 5 stocks, so this makes sense to me.
12. Cash and sitting on the sidelines are OK.
Sometimes things are too expensive, or falling too fast and being in cash is a good thing. Think back to just before the mortgage meltdown hit. If you had stopped out of your stocks at a point near that, and sat by while the market continued its slide, you’d be well positioned to get back in at much lower levels.
13. No woulda, shoulda, coulda.
Avoid second guessing . Have a plan, and be disciplined. Learn from your mistakes, but too much second guessing is a waste of time and energy.
14. Expect correction.
Corrections do not mean something is wrong. Corrections are normal. Corrections are opportunities. Expect them, plan for them, welcome them.
15. Don’t forget Bonds.
Bonds and stocks are in competition. Stocks and bonds are in a tug of war, and influence each other’s price. When interest rates rise, bonds become more favorable and stocks will go down. The reverse is often true. This is why bonds are an important part of diversification.
16. Never subsidize losers with winners.
Don’t sell the winners, and keep the losers. Sell when you need the money, or when the asset drops in value. Have a plan, and stick to it.
17. Hope is not a part of the equation.
Check your emotions at the door. Have a strategy (plan) and be disciplined. Never hold or buy a stock, simply hoping it will recover.
18. Be flexible.
Don’t be afraid to be a bear, or a bull – just be sure it’s based on analysis and fact, not hope and wishful thinking. Have a plan, but be able to adapt your plan when market conditions change.
19. Pay attention to management.
When high level people leave unexpectedly, something is wrong.
20. Patience is a virtue, abandoning value is a sin.
Sometimes a buy and hold strategy is needed, and dropping a value stock (good company with bad stock price) just because the market hasn’t yet realized the value is a bad move. Just know when you buy the stock whether you are buying to hold, or to trade. Be disciplined, and stick to your strategy.
21. Just because a talking head on T.V. said it, doesn’t make it true.
The media is not in the business of making you money. They’re in the business of making money for themselves. They need ratings, guests and advertising.
22. Always wait before buying on pre-earnings announcement.
Wait 30 days to buy after a missed earnings announcement. By that time any ongoing bad news should be factored into the stock price.
23. Never underestimate Wall street.
The Wall street promotion machine can push stock prices up or down, don’t ignore this effect. If Wall street is pushing your stock down, get out.
24. Know your reasons.
Be able to explain the reasons for your picks to someone else, that will force you to have a clear reason and purpose for your buys or sells. It forces you to craft a plan, and not go into something ad hock.
25. There is always a Bull.
Markets, sectors and exchanges operate independently. This past decade stocks have been mostly flat (as a whole), but energy, commodities and bonds have been bull markets. Diversify, but pay attention to trends and bulls.
The astute reader will have noticed that many of these tips come down to having a plan and being disciplined. That’s one of the truisms of investing; something so simple and yet so difficult to perform.
photo by Stefan Schlautmann
Honestly stock market is for people who are patient and willing to learn the in and out of it. If you do not have these traits then don’t ever invest on stock.
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