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Sneak Preview: Ride the Business Cycle

Jim Cramer

Editor's note: This is a special excerpt from Jim Cramer's book, Jim Cramer's Mad Money: Watch TV, Get Rich. To order your copy and read all the rules, click here.

In Real Money, I gave you a list of rules that I'd put together to stop myself from making mistakes at my hedge fund. Those rules still apply, but they're not enough. The world has changed in the last two years, and I've learned a lot more about investing.

That's why I have ten new rules, culled from my worst mistakes on Mad Money. These are new rules for a new time. My last set of rules was designed to help ordinary investors deal with the market. Since starting Mad Money, I've realized that "the market" is an unsophisticated, unhelpful way of approaching your investments. That's why both the show and the rules I've created in response to my mistakes on the show aren't about "the market." They're about the big institutions, the hedge funds and the mutual funds, that dominate "the market." It's these institutions that set prices, because they do most of the buying and selling.

As an individual investor, you are dwarfed by these institutions, and you need to know how to respond to them and how to anticipate their moves if you want to make a lot of money. With these rules, you won't feel or be helpless in the face of the behemoths who whip around your stocks.

My ten new rules, coming out of hard-earned lessons on Mad Money, will help you -- the small, individual investor -- beat the big institutions at their own game. That's the secret now: not just looking at "the market" as an abstract force, but looking at the big institutions that make up the market and anticipating their every move. If you listen to my new rules, and if you watch Mad Money, you'll be able to compete with and defeat the big institutions and make yourself a lot of money. Sane investing in an insane world isn't enough anymore: the market's gotten harder. You need to be a madman to make money in this market, and that's why I'm here to help you get inside the head of the craziest man on Wall Street.

Here are your new rules, the ten lessons I've learned from my most embarrassing moments on Mad Money. Read and learn about the new shape of the market so you can stop crying and start making money with my new disciplines. Most blooper reels just try to make you laugh; with this one, I'm trying to make you money.

1. Resisting the business cycle is futile. It doesn't matter how much you like a stock based on the fundamentals, it doesn't even matter what a stock's "real" relationship to the business cycle is, if you buy a secular growth stock when we're in a cyclical upturn, or a supposedly cyclical stock when we're in an economic slowdown, you will lose. ...

The mutual funds and the hedge funds are the only players who count, and it's their opinions that determine where a stock goes. The big institutions all obey the cycle. They're the reason I drew up my chart about cyclical investing. And if they obey the cycle, then stocks will obey the cycle, too.

The big institutional investors sell secular growth stocks when the economy is strong, and they sell cyclicals when the economy is weak. End of story. If you try to fight this, if you tell yourself that your stock is so good the cycle can't hurt it, if you believe a stock isn't cyclical when the Street thinks it is, you'll lose. ...

I learned this lesson the hard way in UnitedHealth Group(UNH Quote - Cramer on UNH - Stock Picks). I'd liked this stock well before Mad Money premiered on March 15, 2005, and owned it for my charitable trust. At the beginning of the show, the stock was a split-adjusted forty-five bucks a share. I made so much money in the stock and liked it so much that I was calling myself Dr. UNH. ...

My biggest mistake in this stock was that I tried to resist the cycle. I had been extremely positive on UNH during a period where the Fed was raising rates and the economy seemed slow. UNH is a health-care stock, maybe the health-care stock of health-care stocks. That means it has a place on the cycle: it's a secular growth play. You own it when the Fed is raising rates and the economy is weak. If you obey the cycle, you also have to sell it when the economy starts to turn around.

In the first half of 2006, the economy started to turn around. In the first quarter, we had 5.6 percent economic growth -- that's incredible growth, the sign of a healthy economy. Right up until the May 2006 Fed meeting, we were in a noticeable cyclical upturn. That meant all the big funds were selling their shares of UNH to buy shares of more cyclical companies like Caterpillar(CAT Quote - Cramer on CAT - Stock Picks) or Ingersoll-Rand(IR Quote - Cramer on IR - Stock Picks).

I kept telling people to hang on to their UNH in spite of the sector rotation out of health-care stocks and into cyclicals, but that was a mistake. If you'd sold UNH near the top, after it was apparent the cycle was turning and conventional manufacturing business was getting stronger, but well before the stock bottomed in the low forties, you could have saved yourself 20 straight points of pain. (The market switched in May when the Fed braked too hard; the market fled the cyclicals and came back to the HMOs.)

If you learn from the mistake I made here, you won't repeat it yourself. I was insistent that even though there was a serious rotation out of the health-care stocks into the deep cyclicals -- mining, minerals, smelting, and the like -- the fundamentals at UNH, that is, their earnings and their great management team, justified holding on to the stock. I kept telling people that if you'd bought UNH on weakness any time in the last ten years, you made money. Rotations come and go, I said, but the fundamentals ultimately win out, and the fundamentals at UNH were great.

I was wrong. I tried to fight the cycle with the fundamentals, but the fund managers don't care about the fundamentals as much as they care about the cycle. It simply was not worth sitting through a 25 or 30 percent decline in UNH's stock price.

As I learned, and as you should learn, the right thing to do in this situation is sell the stock. Even when you like the stock's fundamentals, even when it's already made you a lot of money, you don't want to fight the cycle. We know buy and hold doesn't work, but neither will buy and homework if you don't take the business cycle and sector rotations into account. ...

It doesn't even matter if the big institutions misbrand a stock as secular or cyclical. The only thing that counts is their perception. Often they'll get it wrong, but if they get it wrong, there's nothing you can do about it, and you shouldn't try to fight them. I'd rather make money than be right, to butcher one of Henry Clay's greatest lines.

If you really like a stock that the Street thinks is out of favor in the cycle, wait for better opportunity to buy it, when it's more in favor and it's more likely to get bought by the big players and go up. When I fought the cycle in UNH and CSX(CSX Quote - Cramer on CSX - Stock Picks), I lost. I'm not going to repeat that mistake.

On the show I say that when you go to the dentist to get a cavity filled you don't even think twice, you take the Novocain. That's stepping aside, selling, letting the stock drop, and then picking it up after the pain. Don't fight the cycle. Don't repeat my mistake, because it'll cost you.

Editor's note: This is one of Jim Cramer's 10 Rules from New Mistakes, New Rules: Ten Lessons From My Bad Calls, a special excerpt from his newest book, Jim Cramer's Mad Money: Watch TV, Get Rich, in stores now. Check back tomorrow for a new excerpt.