Know Speculation From Investing

If you feel comfortable, then you're gonna learn how to speculate like a pro -- and how to avoid speculating when you actually want to invest. I'm focusing on this because the speculative stocks all were really crushed Thursday -- I mean totally taken out back and shot, over and over again. You think Reservoir Dogs was brutal? -- these speculative stocks have been through worse. So if you want to speculate and do it right, this is the time to get started. After I teach you how to speculate right, I'm gonna introduce my own "Mad Money" speculative stock index, and we'll try to make some money with it. (Click here to read about the "Mad Money" speculative stock index.)

Let's lay down some ground rules. I'm gonna tell you what an investible stock looks like, so you can avoid being in a risky speculative play when that's just not what you're after. So how do you know if you're speculating or if you're investing?

Speculative stocks are often companies that don't have earnings yet. They're small, cheap stocks that can move a lot on a little news. They can trade a lot on hype. They are risky, much more risky than your regular stock, which is why you can make so much money speculating, or get destroyed. Usually there are one or two catalysts you're looking for that could really make or break your speculative play. If you've got a stock that looks and feels like this -- you're speculating, you're not investing. For one thing, when you invest, you do it in companies with earnings.

I don't want to trash speculation -- I love it. But you need to know you're doing it, and you need to do it the right way. Here's how you can speculate Cramer-style and actually make some money, as opposed to getting destroyed by the market day after day after day.

1. Never, ever speculate with borrowed money. These are risky investments -- if you borrow money to speculate, that's like taking out a credit card line with Capital One to finance a second home mortgage -- you'll lose it all.
2. Only ever speculate with money you can afford to lose. No retirement money. When you put your cash in risky stocks, you better use expendable cash. And as you get older, you should speculate less and less, because you have less time to earn the money back. I recommend stopping at 54 -- no speculation after you turn 54, because that's the top end of CNBC's key demographic.
3. You can't ever have more than 20% of your portfolio in speculative stocks. Never. Just like you can never have more than 20% in one sector -- think of speculative stocks as their own sector: You need to stay diversified.
4. You've gotta do homework -- speculative stocks are usually trading in the $2 to$10 sweet spot. You have to know how they got there, because no management team aspires to be a $2 stock. Speculative stocks have checkered pasts -- you need to know about them.
5. Make sure they're not covered in debt. If you own stock in a company that goes bankrupt, and a lot of speculative stocks are pretty close to that line, you will be wiped out. All the common stock goes to pay the bondholders.
6. The last thing to keep track of while speculating intelligently is financing. Conexant(CNXT - Cramer's Take - Stockpickr) needs financing next year -- it needs 500 million bucks. That's gonna kill the stock. JDSU(JDSU - Cramer's Take - Stockpickr) did one this year and it ruined the whole story, because what they do is issue these convertible bonds -- convertible into stocks, and that floods the market with new stock and jams the stock down. These companies think this financing is free money, but they're idiots -- it just destroys value.

Bottom line: Know what you're doing so you don't end up speculating when you want to invest, and then if you do speculate -- do it the right way, like a pro.

Editor's note: To read about the "Mad Money" speculative stock index, click here.