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"Making lots of money on a great day is fabulous," Jim Cramer told viewers of his "Mad Money" TV show on Friday, "but rallies are times for action."
Cramer said too many investors don't trade during rallies and thus watch their gains disappear.
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Taking a page from his rally playbook, Cramer told investors they can save themselves a lot of grief by checking "their emotions at the door."
He said investors shouldn't let their emotions prevent them from doing what is needed during big rallies. He said investors often let emotions sway them to hold on to their stocks -- the exact opposite of what they should be doing.
"The goal is to buy low and sell high," he reminded viewers, "so when the market's up big, it's time to lock in some profits."
Cramer also reminded viewers that gains in the market are not really gains until the stocks are sold. He said the way to play big market rallies is to sell in increments during the rally. "Get the great prices while they last," he said.
A Strategy for Selling
Cramer's first rule for playing a rally is to "be really tough on your portfolio." He said investors should not get swept up in the market euphoria, but rather scrutinize each and every stock in their portfolios to determine if it has earned the right to stay there at its new higher price. "Assume that everything is guilty until proven innocent," he said.
Cramer went on to say that when stocks get more expensive, they inherently get less desirable for investors. "The risk-reward equation gets worse as the price goes up," he said.
As a result, it makes sense to trim a portfolio during a rally.
To determine which stocks to sell and which ones to keep, Cramer recommended rating each stock on a scale from one to four. One should be for stocks that investors would own at their current price.
Two should be for stocks that investors would want to own at a lower price. Three should be for stocks to be sold during a rally, and four should be reserved for stocks that should be sold at any price.
Cramer said this scale makes it easier for investors to determine which stocks should be kept and which ones should be sold. During a rally, one's become two's, two's become three's, and so on, as stocks get more expensive.
With this disciplined approach, investors should be able to lock in their gains, he said.
The next rules for playing a rally are to "raise cash" and "don't buy." Returning to the common wisdom of "buy low, sell high," Cramer explained that selling into strength is the only way to stockpile cash so investors can buy stocks back at lower prices later.
He said rallies are the perfect time for investors to stop trading on margin if they have margin accounts in their portfolios. He highly recommended using rallies to strengthen portfolios, not weaken them.
Cramer also said investors should refrain from buying stocks the day after a big rally. He said that "rallies make us overly bullish" and that's dangerous. "Just tell yourself that you missed the opportunity and move on," he said.
According to Cramer, the market will invariably retreat after big moves and only then is it a good time to buy.
What to Drop
Cramer mentioned two types of stocks that he says must be sold into a rally. The first are stocks that have already had great runs. These stocks, Cramer said, may have been attractive at lower prices, but become increasingly less attractive at higher prices.
He reminded viewers that big momentum names also need to be periodically trimmed to remain diversified. He said that no stock should account for more than 20% of a portfolio and even the successful stocks need to be sold.
The second class of stocks that should be sold into a rally are the losers. He said stocks that don't perform well during a market rally often have underlying issues. "Stocks that don't go up aren't ones you want," he said.
A Risky Portfolio
Cramer warned that making too much money during a rally is also a problem. He cautioned that if investors' portfolios are posting huge gains, it probably means that they're taking on too much risk.
Rallies, he said, are the perfect diagnostic tool to assess just how speculative or how risky a portfolio actually is. He suggested that investors use big rallies to examine their portfolios and make adjustments.
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