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Rule 14: Expect, Don't Fear Corrections

You'd think that after the dozens of corrections we've had in the last 20 years, we would get used to the process.

You would think that we would say, "Let's prepare for the correction because it has to be right around the corner."

Yet most people I know act as if corrections are total shockers, the type of thing that never happens.

To me, they are like the rain. I expect it to rain. I prepare for it.

When it comes, I am ready. I have an umbrella and a coat or I stay indoors.

Expect corrections; don't be afraid of them.

Of course, corrections happen at allegedly unexpected times.

The last few we had were preceded by terrific days during --

and we made lots of money and all systems seemed go.

That's when I worry most.

I used to have a rule at my hedge fund:

When I made 2% in a day on the upside,
I knew I was too exposed,
I knew I was too long.

I knew that my portfolio would kill me if we caught a storm.

So as the market lifted, or if my performance was swinging too much to the upside, I would pull back,

sometimes furiously, into strength,

so I would be ready for that big down day.

Sometimes it never occurred,
and I had to swallow my pride days later and come back in.

But when it did occur, I outperformed by so much that my partners thought I was a genius.

Plus, I was ready to buy things with the cash I had taken off the table.


You may not know when a storm might strike.

But we do have barometric readings that help immensely.

When my paid subscription for the S&P's proprietary oscillator registers plus 5,

that signals to me a level of overbought that I regard as dangerous

and I pull back aggressively and wait for a correction.

That might mean that if I owned a portfolio of Intel, PNC Financial, Electronic Arts and Procter & Gamble,
I might be selling up to half of those positions

no matter what,

to be ready for the storm.

Oh, and keep in mind, when that oscillator reaches minus five, it's time to cover your shorts or re-apply your cash as it typically means you are near the end of the sell- off.

If the rough weather doesn't come, I underperform on the upside.

But think of this:
I compounded at 24% after all fees for my hedge fund career,

about twice what the market did during that long stretch -- that was pretty darned good.

The only empirical conclusion:

My method of avoiding the big down days more than made up for having less exposure on the big ramps up.

Action Alerts Plus portfolio manager and TheStreet's founder Jim Cramer has learned a lot over his 30+ years of investing. So he created a list of 25 Rules for Investing that can help you avoid the novice pitfalls that even he fell into on occasion.

Take corrections. Most people act as if corrections are total shockers, the type of thing that never happens, says Cramer

Rule 14: Expect, Don't Fear Corrections

But they are coming. And you better prepare for them.

"To me, they are like the rain. I expect it to rain. I prepare for it...When it comes, I am ready. I have an umbrella and a coat or I stay indoors," says Cramer.

Of course, corrections happen at allegedly unexpected times.

So listen in as Cramer talks about his days at his hedge fund and what he's learned to prepare for those unexpected market downturns. 

And don't forget, we are rolling out one-rule-a-day for the next 25 days! So stay tuned!

Sign up and watch Jim Cramer's 25 Rules For Investing here!

 

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