Cramer's 'Mad Money' Recap: Stock Market Survival School

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This episode last aired on Sept. 1, 2011

NEW YORK ( TheStreet) -- "The game may sometimes feel rigged, but you can protect yourself from being taken advantage of," Jim Cramer told the viewers of his "Mad Money" TV show as he welcomed them to "Cramer's Stock Market Survival School" for investors and home gamers.

Cramer said despite the inherit conflicts of interest on Wall Street and the occasional bad apple, stocks still remain the best way to make money over the long term. He said since 1926, 40% of the S&P 500's total return has come from dividends, which is why he continues to recommend high-yielding dividend stocks.

Beyond that, however, Cramer said there are simple rules investors can follow to help them avoid many of the rookie mistakes that cost individual investors tons of money.

Ignore the Hype

His first rule: Don't fall victim to the Wall Street promotional machine.

Cramer explained that despite Wall Street's barrage of marketing, investors really can manage their own portfolios, avoiding countless fees, commissions and other charges. "Avoid becoming one of those clients that gets abused by their brokers," he said. Doing a little homework on your own can go a long way.

"Never buy something that you don't understand," was Cramer's second rule to live by. He said every investor should be able to defend why they own a stock in two or three sentences. If they can't, then they shouldn't own it. Cramer said only by understanding what you're buying can you truly know whether your broker is putting your interests ahead of his or her own.

Cramer said owning high-quality dividend stocks, doing your own homework and knowing what you own won't guarantee you won't ever lose money, but if a stock does go down at least you'll know why and be able to cut your losses.

Don't Buy on Margin

Cramer's next lesson on investing: Never buy stocks on margin. Cramer said that unlike homes, which provide you a place to live while you pay the mortgage, stocks are nothing more than pieces of paper, and that makes borrowing money to own them just dangerous. He said that while the margin can allow you to make a little bit of money go a long way, it's also a great way to wipe yourself out in the blink of an eye.

Lesson No. 3: Never use market orders. Cramer explained that market orders are when you call your broker and tell him or her to buy or sell a stock without naming a price. "Would you go to the supermarket and say I'll buy this lettuce at any price," Cramer asked? Of course not.

Cramer said the limit orders -- orders where you tell your broker what price you're willing to pay or sell for -- are the way to go. In a case like the May 6, 2010, "flash crash," where stocks were inexplicably falling for no reason as the machines went haywire, Cramer said limit orders would have prevented you from selling a stock for half of what it was actually worth. He said the limit orders are how you protect yourself from getting hosed.

Limit Your Buying

Cramer outlined four more rules that he said will help prevent investors from losing more money than they have to. First up, never own too many stocks.

Cramer explained that individuals are not mutual funds, and they should never own more stocks than they have time to research and understand. Homework, he said, takes time, and investors should commit to spending at least one hour per week for every stock they own.

"There's no good reason to own 30 stocks when 10 high-quality stocks will do just as well," he explained. Having 20 stocks in a portfolio is equivalent to having a part-time job, he said, and that's more effort than most home gamers can muster.

Next on Cramer's list: Don't own too many low-dollar stocks. Cramer said while speculation is a good thing, stocks trading at less than $10 a share are by nature risky, and no portfolio should have more than one. "No company's stock falls below $10 because things are going well," he reminded viewers. Single-digit stocks can fall to zero and take your portfolio with it.

Cramer's third rule: Diversification. Cramer said he cannot preach enough the importance of diversification in a portfolio. He said no more than 20% of any portfolio should be in a single sector. "Just ask the people who doubled down on tech in 2000 only to lose it all," he said. By staying diversified, even if some stocks go down, others may go up and save you.

Cramer's final rule: Dividends. Cramer said most people don't realize the importance of dividends, especially when the markets are getting killed day after day. He explained that when stock prices fall, dividend yields go up, making them more compelling to investors. This "cushion" helps stocks paying dividends go down less, and rebound quicker. "Accidental high yielders," as Cramer calls them, should be a part of every investors' portfolio.

Understand the Risks

"Stocks go down for many reasons that have nothing to do with the underlying companies," Cramer told viewers, as he explained how understanding risk is also an important lesson in investing.

Cramer explained that in the old days, if a company did well its stock was rewarded; if it didn't, its stock fell. But in today's global market -- with exchange-traded funds, futures and high-frequency trading -- this is simply no longer the case. Cramer said that makes understanding why the your stocks are falling crucial.

Cramer said in a really tough market, it seems as though all stocks are trading in lockstep, with the good, bad and the ugly all heading lower. Why is this the case? Cramer said it's because ETFs and hedge funds, along with the futures markets, have turned stocks into commodities, baskets that can be traded at will, despite the underlying fundamentals.

But, Cramer noted, when the selling is done and the panic is over the fundamentals begin to matter again, which is why stocks with great fundamentals are important. He said the "paper risk," or risk that stocks can go down for any reason, is always present in today's market, and investors need to be aware.

Cramer also warned against risks from short-sellers. He said when the Securities and Exchange Commission discontinued the uptick rule in 2007, it allowed short-sellers to gang up on stocks like never before. He said short-sellers have contributed to the failure of banks in 2008, and are at it again, selling European bonds.

Then there are also the double- and triple-levered ETFs, the ones Cramer has railed against many times in the past. He said these funds serve no purpose but to allow big money to make quick gains at the expense of the rest of the market. He said funds such as the UltraShort Financials ProShares ( SKF) have cost uninformed investors big money because they don't work as advertised.

Cramer said his bottom line is that stocks are not cash, and they don't act that way. Investors need to be aware of market risks, paper risks and the risks of short sellers, before they invest their nest eggs.

You're on Your Own

Cramer said his final words of warning to investors in this choppy market is to always remember that there is no lifeguard on duty at the Wall Street pool. He said the SEC, which should be working to level the playing field and protect individual investors, isn't doing its job.

Cramer said the SEC seems to favor the big-money hedge funds, and the high frequency traders who turn over their portfolios 11 times a second, over the home gamers trying to invest their 401(k)s.

He said today's SEC bears little resemblance to that of the Arthur Levitt SEC from 1993 to 2001. He said during that era, the SEC worked hard to make the markets safe for individuals. But under the laissez-faire George W. Bush-era SEC, all that changed, and President Obama has done little to roll back the damage.

Cramer said the SEC does not "have your back" when it comes to investing your IRA or 401(k). He said investors need to protect themselves from the Bernie Madoffs of the world who offer returns that truly are too good to be true. He said the technology has outpaced the human's ability to deal with this newfound firepower.

"We don't have to like it," he concluded, "but we do have to get used to it."

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-- Written by Scott Rutt in Washington, D.C.

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At the time of publication, Cramer's Action Alerts PLUS had no position in stocks mentioned.

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.

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