There are many things you need to balance to be a great investor, Jim Cramer told his Mad Money viewers Wednesday, as he dedicated the entire show to sharing some of his most important investing wisdom.
Without the right philosophy and discipline, it's easy to get yourself into trouble, Cramer added. But above all else, the thing you really need to be a great investor is good judgment.
Good investing habits aren't something that can be taught in an hour. Over time, investors need to learn how to think about stocks, how to process information and how to judge what they're seeing and hearing in the markets.
Know What You Want From Your Investments
The first step in having good judgment is to know your investing objectives. One size does not fit all when it comes to investing, and without a clear goal in mind, it's very difficult to pick the right stocks to get you there. If you're saving for retirement, a high-flying stock like Netflix (NFLX) might not be right for you. But if you have a long-term time horizon, slow-growing stocks with bountiful dividends may be the perfect fit.
Investors must always determine what they want from a stock before they buy it.
Once you have your goals ironed out, that's when the homework happens. Regular viewers of Mad Money may be tired of hearing about homework, so here's the short version. You need to learn what a company does, how it makes its money and why you're planning to buy it. If you can articulate your thesis to at least one other human being, then you're cleared to make the purchase.
The Internet makes homework easy, Cramer said, as a company's reports, filings and conference calls are all now easily found online. Once you've built a solid portfolio of five to 10 diversified stocks, Cramer said, the next step is to be prepared for heartache.
No matter how solid your theses, the fact is that not all of your picks will be winners and even fewer of them will stay winners. That's why investors need to stay flexible. Investing is a dynamic business and when the facts change, you have to be willing to change your mind.
The notion of "buy-and-hold" is nonsense, Cramer said. You cannot afford to fall in love with your stocks. Companies make mistakes. Things change. When that happens, your thesis is no longer valid and it's time to move on.
Learn From Your Mistakes
Cramer's next lesson for investors is to acknowledge the emotional side of investing. Sometimes, he said, managing your emotions about a stock -- especially a loss -- is the hardest part.
You will make mistakes, Cramer reminded viewers, and when that happens, the worst thing you can do is start asking "if only."
"If only I had done this" and "if only the company had done that," is a dangerous game that will only drive you crazy, Cramer said. This emotional circular logic will cloud your judgment, and more importantly, keep you from finding your next great investment idea.
"When someone shows you who they are, believe them the first time," author Maya Angelou said, and Cramer said this quote applies to investing as well.
Sometimes, a company's CEO can be misleading or even outright dishonest, but on whole, Cramer said, those in corporate America whom he's met are surprisingly honest individuals. When Salesforce.com (CRM) CEO Mark Benioff told viewers in the depths of the recession that Salesforce would be OK, it was. When Domino's Pizza (DPZ) CEO Patrick Doyle told Cramer in 2010 that the company was going to turn itself around, it did.
That's why, when a company pre-announces an earnings shortfall, investors need to sit up and take notice. As he noted earlier, it's far too easy to get emotional and think "it can't be that bad." But that's dangerous thinking, Cramer warned, as no one knows a company's business better than those who are running it.
Never grab for a falling knife, Cramer cautioned. If a CEO says things are bad, take their word for it.
Markets Make Mistakes, Too
Finally, Cramer said, just as you the individual will make mistakes, so too will the market. In fact, the market makes mistakes every day. The stock market is, after, just a market, and one that is prone to the distortions of things like ETFs and index funds.
With the advent of ETFs and index funds, stocks are lumped together into baskets with companies that have nothing to do with their business. That makes companies far less in control of their destinies than they used to be.
Have you ever noticed a company report a great quarter only to see its shares tank immediately after? That's often the pull of markets overriding those who wait around for the conference call to hear what the company has to say. That's also why, many times, the plunge is only temporary and quickly reverses itself.
Investors who have done their homework, however, can spot these distortions and use them to their advantage.
Search Jim Cramer's "Mad Money" trading recommendations using our exclusive "Mad Money" Stock Screener.
To watch replays of Cramer's video segments, visit the Mad Money page on CNBC.
To sign up for Jim Cramer's free Booyah! newsletter with all of his latest articles and videos please click here.
At the time of publication, Cramer's Action Alerts PLUS had a position in CRM.