Questions like, "How does this company do?" and "How do they make money?" go a long way, said Cramer. How can you ever know to cut your losses if you don't know why you bought it in the first place?
Don't Buy on Margin
Cramer's next lesson on investing: Never buy stocks on margin. Cramer said that unlike homes, which provide you a place to live while you pay the mortgage, stocks are nothing more than pieces of paper, and that makes borrowing money to own them just dangerous. He said that while margin can allow you to make a little bit of money go a long way, it's also a great way to wipe yourself out in the blink of an eye.
Lesson number three: Never use market orders. Cramer explained that market orders are when you call your broker and tell them to buy or sell a stock without naming a price. "Would you go to the supermarket and say I'll buy this lettuce at any price," Cramer asked? Of course not.
Cramer said the limit orders, where you tell your broker what price you're willing to pay or sell for, are the way to go. In a case like the flash crash of 2010, where stocks were inexplicably falling for no reason as the machines went haywire, Cramer said limit orders would have prevented you from selling a stock for half of what it was actually worth. He said the limit orders are how you protect yourself from getting hosed.
You Can Own Too Many StocksCramer outlined four more rules that he said will help investors from losing more money than they have to. First up, never own too many stocks. Cramer explained that individuals are not mutual funds, and they should never own more stocks than they have time to research and understand. Homework takes time, and investors should commit to spending at least one hour per week for every stock then own. "There's no good reason to own 30 stocks when 10 high quality stocks will do just as well," he explained. Having 20 stocks in a portfolio is equivalent to having a part-time job, he said, and that's more effort than most home gamers can muster. Second on Cramer's list: Don't own too many low-dollar stocks. Cramer said while speculation is a good thing, stocks trading at less than $10 a share are by nature risky and no portfolio should have more than one. "No company's stock falls below $10 because things are going well," he reminded viewers. Single-digit stocks can fall to zero, he said, and take your portfolio with it. Cramer's third rule: Diversification. Cramer said he cannot preach enough the importance of diversification in a portfolio. He said no more than 20% of any portfolio should be in a single sector. "Just ask the people who doubled down on tech in 2000," he said, "only to lose it all." By staying diversified, even if some stocks go down, others may go up and save you. Cramer's final rule: Dividends. Cramer said most people don't realize the importance of dividends, especially when the markets are getting killed day after day. He explained that when stock prices fall, dividend yields go up, making them more compelling to investors. This "cushion" helps stocks paying dividends go down less, and rebound quicker. "Accidental high yielders," as Cramer calls them, should be a part of every investors' portfolio.
Understanding Risk"Stocks go down for many reasons that have nothing to do with the underlying companies," Cramer told viewers, as he explained how understanding risk is also an important lesson in investing.
Check Out Our Best Services for Investors
Jim Cramer and Stephanie Link reveal their investment tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
Jim Cramer's protégé, David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.
- Model portfolio
- Stocks trading below $10
- Intraday trade alerts
Check Out Our Best Services for Investors
Jim Cramer's protégé, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
Every recommendation goes through 3 layers of intense scrutinyquantitative, fundamental and technical analysisto maximize profit potential and minimize risk.
Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.