Essay On Jim Cramer’s Twenty-Five Rules For Investing

Don’t buy all at once (Rule 3). This rule is based on prudency concept and is probably willingly followed by the traders who are risk averse. The staging of stock purchase, per Cramer’s advice, can ensure the trader against fluctuations if the company value goes down significantly and rapidly. Buying in increments with careful analysis when and how much to buy, can ensure the highest deal value and the optimal prices. Still, the dark side of the issue is the risks associated with significant price fluctuations, especially when the purchase is spread in time: for a relatively short time period the target company can become overpriced and the targeted amount of stock units will no longer be a profitable deal. The balanced and risk-neutral approach will possibly be buying in increments, but split into reasonable parts within a reasonable time span. The number of increments and units within each increment and the time lags between purchases will depend on each individual trader’s decision based on his sensitivity to the market volatility and the fluctuations in a particular company P\E ratio.
Diversify to control risk (Rule 5). This advice reflects one of the most significant risks management strategies: diversification by grouping companies from different sectors in the investment portfolio. As sector risk is one of the most viable risks, a balanced mix of the stock of the companies from different industries (e.g. IT, retail, oil and gas) can mitigate it. Even in case of some sectors outperforming the others, it is not advisable to invest in them 100% of amount available as any external environment changes (e.g. legislation amendment or fraud investigation) can lead to the overnight dramatic decrease in stock value for the companies from this industry area. In case of diversified portfolio, with at least top 5 holdings being from different industries, these risks are insured. If anything goes wrong with the holdings from one industry sector, the trader will be hedged or at least partially hedged against losing on all its stocks by another part from its portfolio from a different industry sector.
Do your stock homework (Rule 6). When investing into the company stocks, the appraisal of the company’s performance is essential. Cramer indicates lots of valuable sources the information can be derived from – the annual reports, the SEC filings and the conference calls. The information available from mass media is second grade evidence and some types of it (TV in particular) are discussed below. Still, careful assessment of all sources is necessary to form a final opinion where the company moves. Such a thorough analysis of all the holdings’ performance will allow the trader to obtain a really meaningful set of ratios and company valuation, avoiding the traditional ratios limitations. Sometimes the annual reports analysis is helpful in understanding the differences in different market players’ performance stipulated by different basis for ratios calculation or different accounting policies regarding some particular items. Also, the carefully collected data can be a prompt for some non-financial indicators which will not be easily derived from NASDAQ quotes but which will be embedded in the company value after a while. If the exercise is done regularly, it will let the individual trader to assess the company’s current position more accurately, both rationally and heuristically.Thus it will lead more informed decisions of the traders of whether to invest in a particular company.
Bad Buys won’t become takeovers (Rule 10). Here Cramer addresses the typical mistakes of some beginners in the stock market who buy the shares of the companies with a weak or worsening financial performance in the hope for the acquisition\takeover which will be followed by thecompany value increase. However the rule “buy cheap sell expensive” is not working in these cases as both per statistic data and mere logic, it is more difficult to sell the company with financial performance problems at good price. Buying the cheap stocks of poor performers will not result in beating the market as the funds invested in such stock actually do not earn returns. More reasonable strategy would be investing in more expensive stock, being assured of the company good financial position and good reputation. If the brand name is reliable and produces good stock yields from years to years, any stock market theories will conclude these stocks will not fall so drastically if the company value and P\E ratio go down. Following Cramer’s Rule 10 can ensure the trader’s sustainability and more predictable outcomes of the deals.
Don’t own too many names (Rule 11). Actually this advice follows up the principles of risk management stated by Rule 6. On the one hand, if performance of all the companies whose stock the trader posesses is monitored closely on week-by-week basis, the process becomes time-consuming, with costs clearly overweighting the benefits, when the number of the holdings reaches hundred. It is definitely easier to track the performance of selected 5-10 companies tracking their price fluctuations and market data than to try predicting the market behaviour for hundreds. On the other hand, for the purpose of risk diversification, sometimes it may be more prudent to invest in some additional positions (pricing and market trends, reduced volatility, possibility of long-term capital appreciation etc.) making them a kind of “by-products” (high quantity items still representing a minority\low share of the portfolio).The decision should be made individually based on the current market situation and individual trader’s risk attitude.
No woulda shoulda couldas (Rule 13). This rule may seem contradictory as in Rule 11 Cramer says that as a hedge fund manager he used to spend 3 hours a day to analyze the mistakes of the previous day. For general public, the advice to avoid regretting the past mistakes (what could have been done and what gain could have been earned), may seem a recommendation to go forward without a careful and detailed assessments of past failures. Still Cramer apparently means another thing as he advises to avoid not critical analysis, but destructive thinking. Focusing too much on the unsuccessful deals results, more emotionally than rationally, could destroy the trading. Attaining the inquisitive approach and critical thinking to each transaction, with focus on its reasons and not its results, can help the trader in developing the analytical abilities which will be enhanced as soon as the beginning trader becomes a more mature market player.
Don’t forget bonds (Rule 15). This rule, as some previous ones, is clearly an example of risks diversification strategy, mitigating the risks of 100% investment in the stock market by adding the bonds to the portfolio. Sometimes people are anaware of bond market rules and trends though the bonds can be a perfect investment goal. Normally bonds, loan notes and debentures are issued by government and corporations to raise finance and can assure regular interest payments. Thus combination of stocks and bonds can secure the trader a favorable mix of short-term earnings and long-term capital gains. The spot yield curves which are reguraly published by central banks can be usefiul to estimate the price or value of a bond, the term structure of interest rates, and the yield to maturity.
Be flexible (Rule 18).This rule deals with stock market risks including many unknowns and “black swans”.No one knew that Enron or Lehman Brothers would collapse an no one could predict up to the decimal point how much the interest rates would rise in some years. Neither could anybody know Cramer’s recommendation of any particular company, based on his personal stock appreciation, on CNBC show, will lead to a sudden overnight growth in its stock price and will be marked by appearance of a new financial term (“Cramer’s Bounce”). That’s why the flexibility, together with the ability to quickly react to the market movements and to be prone to any changes, is a core competency for the trader. The traders should possess both the robustness to protect themselves against negative market events and the abilities to explore and use positive ones. Critical analysis of both “known unknowns” and “unknown unknowns” will let the trader to sucessfully manage the unfavorable events to the extent of their power. Finally, it correlates with Rule 6, which consistent application lets the trader to combine both rationale and heuristic approach in evaluating the most unknowns that can influence the company forecasts. These types of unknowns can be handled by making estimates, with the appraisal of various possible outcomes. Cramer’s story with the loss on stock which would have been much higher if not cut timely is a bright example of the estimate the trader can make with a certain degree of accuracy if he has flexibility.
When the chief retreats, so should you (Rule 19).The advice is based on the principles that CEO never quits the company for personal reasons.Of course the leave of CEO will be immediately embodied in the stock price, but Cramer’s advice is about a prompt reaction before this movement will be reflected. Still, the finance history knows both the examples where CEOs quitted the company with their successful return in some years, having invigoured the company. When Steve Jobs quitted Apple with a subsequent return years after, it made the company prosperous and increased value of Apple’s business. Jack Welch’s retirement from General Electric was not the evidence of poor performance or going concern issues either. Thus, CEO retirement should rather be analyzed, to the best of one’s knowledge, following another Cramer’s advice (Rule 6) to obtain the information from all the possible sources and to make conclusions after its analytical appraisal.
Be a TV critic (Rule 21). That rule is related to reliability and the credibility of the resources the trader should get information from. The key message is that TV information as mass media data source should be taken into account but not relied too much upon. TV sometimes can provide sensitive and almost insider information which can really be useful in making the stock decisions but the value of TV information in general should not be overestimated. Striking the balance, with critical approach to what was heard on TV, is necessary to derive a well-grounded conclusion and make prudent forecasts. The advice is quite useful for general audience as it teaches the traders to critically evaluate the sources of information, to assess its credibility and the degree of reliability the data they get to take weighted decisions on their investments.

Works Cited.

“Cramer’s Twenty-Five Rules for Investing”. The Street, n.d. Web 12 Feb 2015.