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Jim Cramer devoted his "Mad Money" TV show Monday to explaining what market players can learn from the hedge fund Amaranth's mistakes.
"The $9 billion hedge fund that fell like a house of cards," Cramer called it.
What Amaranth tells us is that everyone is vulnerable, Cramer said. "You cannot pick, invest in, or trade stocks blindly."
Amaranth's collapse was "awful" because the fund made many mistakes, Cramer said. The first lesson people can learn is that "hubris is not a good investment strategy," he said.
When people become too proud, they might get reckless, like Amaranth did, Cramer said.
"It put too many investing eggs in the energy-sector basket," he said. "Scale back risk a little bit, as it's not smart to take huge risks."
Speculate only with 20% of your nonretirement portfolio, Cramer said.
Lesson No. 2 is "don't take on enormous amounts of debt when trading." Amaranth's use of margin was "idiotic" and "irresponsible," Cramer said.
"Buying on margin is a crime, and before you know it, you'll be sitting on a gigantic amount of debt," Cramer said. "Cut margin back."
Third, "even though you think you know more than the market, don't act that way." Amaranth thought it "was the market in natural gas," but the market can't be manipulated long term, Cramer said.
"Overconfidence is a sin," he said.
Cramer said investors deserve to know what mutual funds and/or hedge funds are doing with their money. Once you know what your money manager is up to, you need to be sure he's diversified, he said.
"Amaranth was a firm that was 50% into natural gas," Cramer said. "That's not risk management; that's a coin flip."
People cannot call themselves professionals if they're not diversified, he said.
Ask questions and evaluate your money manager, Cramer said. Figure out how old your money manager is because "with age comes experience" and find out how well he's done in bad economic times," Cramer said.
"Some of these young
ones haven't even seen bad times," Cramer said. "A money manager that can make money in bad times is a good money manager."
After going through what Amaranth means for the individual investor and for money managers, Cramer told viewers he was going to get more philosophical because "that's often the most useful advice."
As a former hedge fund manager, he said he has some broader observations of Amaranth, the first one being that even professional money managers "can be fooled."
"There are layers upon layers of people who are getting fooled in the Amaranth story," Cramer said.
People have to understand themselves what they are doing with their money, he said. "You can't just sit back and trust someone to make you money."
If people are not able to give three bullet points as to why they are in a certain stock, they need to get out, Cramer said, adding that people also need to gain control of their portfolios.
With enough work, people should be able to beat professionals and manage their money themselves, he said.
Moreover, "don't bet on things that are unpredictable, like the weather," Cramer said.
Amaranth bet the country would have a hot summer and bad hurricane season and consequently would use a lot of natural gas. People should learn from this and make sure not to convince themselves that the market is a slot machine, he said.
Finally, "don't get attached to stocks you own," Cramer advised. Learn to take some off the table, unlike Amaranth, which couldn't let go of some natural gas when it was up.
Cramer asked his guest
President and CEO Alan Levy why people should be in this stock if the company doesn't have any revenue.
"Because I think what we're doing is so exciting and has such great potential," Levy said. "We're developing a therapy that will help millions of people who have suffered a stroke, and today there is absolutely nothing effective for them."
"We started work on this back in 1999 because we saw tremendous opportunity and tremendous need," Levy said. "Now if someone suffers a stroke, there is no effective therapy for them."
But Northstar has developed a therapy that can treat people months and even years after a stroke to help them improve motor functions, Levy said, adding that the company's depression study is just getting started now.
When Cramer asked Levy to give him a sense of what happens to people who suffer a stroke now, Levy said these people are given some rehabilitation, and if they have some permanent disability, they are forced to live with it because there is currently no therapy for it.
To view Cramer's interview with Alan Levy, please click here.
Cramer was bullish on
Johnson & Johnson
Level 3 Communications
Cramer was bearish on
Oregon Steel Mills
In the "Sudden Death" round, Cramer was bullish on
. He was bearish on
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At the time of publication, Cramer was long Johnson & Johnson.
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