Cramer's Trading School: The Golden Rules on Losses

The essence of good trading is never to let a gain turn into a loss. The essence of good investing is never letting your losses run.

When I first started at Goldman Sachs, Richard Menschel, my department head and perhaps still the greatest man I have ever met in this business, told me these lessons. He warned me that if I was not careful I would impale my clients on some stock at some time that would wipe out all of the other good work that I had done for the customer.

Over and over again he would explain that when that losing security came along you would not be able to asterisk the account statement with "if it were not for Memorex Telex we would have done quite well," or "oops, we did great except that Bethlehem Steel preferred which went into arrears wiping out everything else we made."

Yet, I see this lesson of investment violated all of the time. People ride losses down forever. If you have discipline this won't happen. So let's instill some discipline. For those of you who wish they could have asterisked their statement, why not develop a down 15% and you are out. You can always come back to the stock if you want to. But this way you avoid the fairly common problem of blowing yourself out of the water with one security.

It's the second lesson that I find eludes all but the best traders on Wall Street. When you are up on a stock, when you are playing with the house's money, you must never ever let that stock go back to the loss column. Mrs. Cramer would slap me upside the head anytime I ever did it, and if you do it in my shop still you will get the coldest shoulder imaginable. When I see someone who has ridden a gain into a loss, I look at that person as if they were up by six games with just 10 games to go and they muffed the pennant.

In other words, I look at them as a loser.

Why is this rule so inviolate? I think it is because good traders have to build up, have to keep exercising that discipline that allows them to have no big losses and a whole schedule full of wins.

When Mrs. Cramer started in this business a long time ago, a bright young research assistant rear echelon ^#$%#$%# suddenly thrust into the Battle of the Bulge at Steinhardt Partners, this second rule enabled her to survive and prosper. She would do hundreds of trades, and try to get stopped out or get protection from a broker to keep the losses low. But once she was up she guarded her gains as she would crown jewels. She always had one foot out on every trade. And she developed a storehold of small wins that would embolden her to stick around a little bit longer each time but never have a win taken away.

As I look through the roster of our ever-growing membership, I am struck by how many of you are just beginning. Between when Mr. Menschel first laid down the law, and my wife enforced it, I broke both these rules hundreds of times. Don't you do the same.

Part two

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