Cramer's 'Mad Money': Staying in the Game

Cramer gives home gamers insights on how to trade in a troubled market.
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"If you want to use your money to make money, stocks are your best shot," Jim Cramer told viewers of his "Mad Money" TV Show Friday.

He said high quality dividend paying stocks are still the single best asset class over any 20-year period. The key, he said, is to stay in the game, even when every instinct you have tells you to give up.

Cramer said staying in the markets is hard, especially after a big loss. He said there's no magic formula to turn all stocks into winners, so being able to deal with losing a boatload of money is a necessity. Investors need to expect market corrections, not fear them, he said.

Corrections are hard to predict, said Cramer, and investors shouldn't beat themselves up for not seeing them coming. But, he said, if investors treat corrections as a natural part of how the market works, and something they can't avoid, their frustration will be minimal.

Cramer said the thing to remember is to always have a superior attitude and a superior state of mind.

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The Right Mix

"If we've learned anything from the market meltdown of 2008, it's that diversification is more important than ever," Cramer told viewers. He outlined 10 steps investors should take to achieve a truly diversified portfolio.

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Cramer said investors need to always treat their portfolios as two separate streams, a conservative stream for retirement, and a second for their discretionary portfolios. He said each stream should contain at least five stocks, but no more than 10. Investors should be prepared, he said, to devote at least one hour a week of homework to each stock in their portfolio.

Once investors have decided how many stocks to research in their portfolios, he said the stock they should pick should be one from their neighborhood, a local name that can relate to.

Second, Cramer said a portfolio must include a defensive, recession-resistant company. Third, investors should consider a high-quality cyclical stock. Next, Cramer said investors needs a high quality brand name stock in the mix, along with a financial stock.

Rounding out a well balanced portfolio should be a speculative stock, said Cramer, something to add some excitement.

He said there should also be a retailer in the portfolio, a tech stock, an energy play, and a gold stock.

He said none of these stocks should account for more than 20% of a portfolio.

Timing Is Crucial

Investors looking to get the edge on Wall Street need to understand one thing, said Cramer, and that's the business cycle.

"It's huge," he said, "50% of how a stock moves depends on the sector it's in." He said the reason for this is that big fund managers are committed to sector-based thinking, and they're the big buyers and sellers that set prices.

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Cramer explained there are two types of companies: cyclical ones that do well when the economy is growing, and secular companies that aren't sensitive to the strength or weakness of the economy. It's the secular names, he added, that are the ones to own during a recession.

Cramer said that at the top of the business cycle, right before the

Federal Reserve

is about to raise rates, that's when to buy the secular names. And at the bottom, when people can see the light at the end of the tunnel, is the time investors should swap out of those names and back into the cyclicals.

Why jump back into the cyclicals at all? Cramer said the reason is simple. At the bottom, all of the earnings estimates have all to be cut, making the cyclicals' price/earnings ratios low. This, in turn, makes them look cheap and promotes the increased buying.

The First Hint

Avoiding losses, said Cramer, is another important lesson to learn. He said that one way to avoid huge losses is to pay attention to a stock's price/earnings multiple and look for multiple contraction, a period when the market decides it's just not going to pay a high premium for a certain stock.

Cramer said when a stock catches a case of multiple contraction, it only gets cheaper and cheaper, as the market decides it's willing to pay less and less for a company's future earnings. But, he said, investors needn't worry too much, as there is often time before the symptoms of multiple contraction set in.

Cramer used

Whole Foods

(WFMI)

as an example of multiple contraction. On July 31, 2006, Whole Foods, a high-flying, high-multiple stock, reported earnings with just a hint of negativity in their same-store sales growth. For the next two years, the stock just drifted lower and lower as investors decided Whole Food just wasn't worth the multiple they were giving the company.

Cramer said his bottom line is that investors need to sell high-multiple names at the first sign of a slowdown.

Protect Yourself

Cramer said his last rule for staying in the game is to know your broker. "Some brokers will rob you blind," he said, "and you're probably handing them your wallet."

Cramer explained that many amateur investors make the mistake of placing market orders, which get placed at whatever the current price of a stock is, rather than limit orders, which specify a price that the investor wants to pay.

Cramer pleaded with viewers to always use limit orders. He said that by using limit orders, investors can get way ahead of the pack, adding there's absolutely no risk in using them. Limit orders, he said, are the only way to know a broker's not cheating you.

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At the time of publication, Cramer was not long on any stock.

Jim Cramer, host of the CNBC television program "Mad Money," is a Markets Commentator for TheStreet.com, Inc., and CNBC, and a director and co-founder of TheStreet.com. All opinions expressed by Mr. Cramer on "Mad Money" are his own and do not reflect the opinions of TheStreet.com or its affiliates, or CNBC, NBC UNIVERSAL or their parent company or affiliates. Mr. Cramer's opinions are based upon information he considers to be reliable, but neither TheStreet.com, nor CNBC, nor either of their affiliates and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such. Mr. Cramer's statements are based on his opinions at the time statements are made, and are subject to change without notice. No part of Mr. Cramer's compensation from CNBC or TheStreet.com is related to the specific opinions expressed by him on "Mad Money."

None of the information contained in "Mad Money" constitutes a recommendation by Mr. Cramer, TheStreet.com or CNBC that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. You must make your own independent decisions regarding any security, portfolio of securities, transaction, or investment strategy mentioned on the program. Mr. Cramer's past results are not necessarily indicative of future performance. Neither Mr. Cramer, nor TheStreet.com, nor CNBC guarantees any specific outcome or profit, and you should be aware of the real risk of loss in following any strategy or investments discussed on the program. The strategy or investments discussed may fluctuate in price or value and you may get back less than you invested. Before acting on any information contained in the program, you should consider whether it is suitable for your particular circumstances and strongly consider seeking advice from your own financial or investment adviser.

Some of the stocks mentioned by Mr. Cramer on "Mad Money" are held in Mr. Cramer's Action Alerts PLUS Portfolio. When that is the case, appropriate disclosure is made on the program and in the "Mad Money" recap available on TheStreet.com. The Action Alerts PLUS Portfolio contains all of Mr. Cramer's personal investments in publicly-traded equity securities only, and does not include any mutual fund holdings or other institutionally managed assets, private equity investments, or his holdings in TheStreet.com, Inc. Since March 2005, the Action Alerts PLUS Portfolio has been held by a Trust, the realized profits from which have been pledged to charity. Mr. Cramer retains full investment discretion with respect to all securities contained in the Trust. Mr. Cramer is subject to certain trading restrictions, and must hold all securities in the Action Alerts PLUS Portfolio for at least one month, and is not permitted to buy or sell any security he has spoken about on television or on his radio program for five days following the broadcast.