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Editor's note: This show originally aired on Dec. 26, 2006.
To make money in the market, people need more than good stock picks and good advice about the state of the market, Jim Cramer told viewers of his "Mad Money" show Wednesday. "They need discipline."
Regular fans of "Mad Money" should be familiar with
Jim Cramer's Real Money: Sane Investing in an Insane World
, Cramer said, as he's devoted a few shows to explaining some of the rules he's laid out in his book.
Cramer: You're So Money, Farnoosh
But because Cramer wrote that book a long time ago, and though its rules are still valid, he's come up with more rules designed "to help the individual investor beat the big institutional money managers on the Street." Cramer has assembled these rules in another book:
Jim Cramer's Mad Money: Watch TV, Get Rich
Although people might not like "Cramer the disciplinarian," he said his new book, which has 20 brand-new rules, should prevent market players from losing money. And because Cramer's aim is to help make people rich, he went on to explain five of those new rules.
Cramer's first new rule is, "There's a market for everything; pay attention to how it works." Investors need to remember that there are lots of different reasons why stocks are traded in a stock market and that there are submarkets, he said.
Although it makes "total intuitive sense," most people rarely keep in mind when investing that there's a market for oil stocks, a market for newly public stocks and a market for small-cap value stocks, all of which are governed by supply and demand, Cramer said.
"If you ignore the supply and demand for certain kinds of stocks, or stocks in general, you'll be totally perplexed by the market," he said. "This rule is especially true for trendy, hyped-up stocks."
Taking the ethanol trade in 2005 and 2006 as an example, Cramer said at the end of 2005, because the supply of ethanol stocks was so low and demand was "intense," people were able to make "truckloads of money" in stocks such as
Archer Daniels Midland
(ADM - Get Report)
(ANDE - Get Report)
But then the ethanol game changed, as a company called
came public on June 14, 2006, and added to the supply of ethanol stocks, he said. The VeraSun initial public offering was further followed by IPOs of companies with worse fundamentals -- but just as much ethanol exposure.
"If you'd just been paying attention to the fundamentals, or to the hype about ethanol in the media, you would've been caught totally off-guard by the downturn in ethanol," Cramer said.
"The day VeraSun came public, I called the end of the ethanol, and I got it right ... because I was paying attention to the amount of ethanol stock in the market and the market's demand for it."
Know What You Hold
Moving on to rule No. 2: when playing a rally, "make sure your stocks actually fit the bill," he said. "Don't be bamboozled by what sector your stock belongs to. Instead, know precisely what you own and why you own it."
Although Cramer always advises his viewers to do their homework and know what they own, this rule is different because the point is to recognize that "sectors don't always matter when it comes to giving stocks momentum."
People should never confuse a rally within a sector for a rally of that entire sector, he said.
Also, he knows people don't always do their homework before buying stocks -- behavior Cramer said he does not approve of. He iterated that he believes people need to spend at least an hour a week per stock they own doing homework to make sure the stock is still a "sound" investment.
Breaking down the rule, Cramer said there are times people will see a rally in an entire sector. For example, if the
cuts rates, investors will see a rally in almost everything cyclical, or if the economy gets "pummeled," people will see a rally in consumer staples and food and beverage companies, he said.
"These are broad, sector-based rallies and you don't have to be all that discerning to pick out a good stock that will make you plenty of money when these things happen," Cramer said. "But most rallies don't work that way."
Market players will hear about health care rallies or transports rallies or tech rallies, but that doesn't mean the whole sector's rallying, he explained, because within sectors there are industries.
This is what really counts and what people should pay attention to, Cramer said.
Cramer said he came up with this rule on June 22, 2005, when he got "caught up" in the idea of a tech rally and picked the two names that most represent tech:
(MSFT - Get Report)
(CSCO - Get Report)
. But later Cramer realized that the so-called tech rally was really a gadget rally.
"I fooled myself because Microsoft and Cisco had always been the tech stocks," he said. "It didn't matter that they didn't have any real exposure to the rally, because I was thinking of it as a tech rally, and in a tech rally you buy Microsoft."
It's easy to mistake a rally in an industry for a rally in the sector it belongs to, Cramer said, but if people remember this second rule, they should be able to make a lot more money.
He said his next rule is "provisionally true" and though at some time in the future he can see it being revoked, he doesn't believe it will be soon. The rule is that "Latin America is always a trade."
Every so often there's a "huge wave of interest in Latin American stocks," where everyone in the business who owns these stocks believes that Latin America is an "amazing, long-term growth story," Cramer said.