Trading a Selloff - Cramer's Mad Money (8/7/08)

Includes: QQQ, SPY
by: Joan Wickham

Stocks discussed in the in-depth session of Jim Cramer’s Mad Money TV program, Thursday, August 7.

Note: The following program is a rebroadcast of a show that first aired on December 27,2007.

Playing by the Book

Cramer told viewers that what is needed when the economy is headed for a downturn is a good playbook. While many investors are tempted to jump ship, Cramer recommends taking advantage of downturns by hunting for good stock on the cheap. However, it pays to distinguish real from false opportunities. Cramer said as a hedge fund manager, he could sow the seeds for big profits on the down days because declines allowed him to get into a stock at the right price; "You know when you want to pay the most attention to stocks? When they're going lower."

Cold, Hard Cash

To take advantage of declines, Cramer says every investor needs handy cash to take advantage of bargains immediately; "Most homegamers are fully invested all the time, meaning their portfolio is 100% stock and zero cash. ... My rule is to never have less than 5% cash," Cramer added, "A selloff is only as good or bad as you make it. If you own nothing and you're trying to build up your portfolio, a selloff is a gift."

Ranking System

Cramer recommends investors take time to evaluate stocks every Friday, rather than in the heat of trading. He suggests dividing potential stocks into four categories. The first are serious buys. The second group include stocks that are worth buying if they drop a bit in price. The third type of stock is a sell, but only if it rallies 5-7% and the fourth group includes immediate sells. A big selloff will substantially affect these rankings, and investors should re-evaluate their stocks; "In a selloff, you don't want to sell nothing and buy more of everything. That's reckless." Cramer insisted that it is not panicking to sell bad stocks at the very beginning of the decline and to use the money to buy stocks in the first and second categories.

When Bad Things Happen to Good Stocks

Cramer urged viewers learn the difference between a broken company and a broken stock, and to buy good companies which have experienced an unfair decline. When trying to determine which companies are broken, Cramer used the housing crisis as an example; "If you're looking at a company that's part of the reason for a correction, you're in the wrong place." He added, "A company becomes broken when your reason for liking it goes away." On the positive side, infrastructure went down along with housing, and the decline provided a good opportunity to buy some quality companies; "You want to look for stocks in areas that are independent of what's ailing the market." Cramer urged investors not to be fooled by the low price tag on broken companies and said they should be completely avoided.

Correction Mega Sale

A correction is nothing more than a Mega Sale on a good stocks, said Cramer and he would begin looking at stocks that are off their highs. However it is important not to be blind to potentials reasons the stocks are down. Cramer would also use corrections to hunt for dividend stocks and said a decline is a chance to find investments with higher yields. He suggested checking that earning are at least double the size of the dividend to ensure the investment is safe.

Go with the Herd

Selloffs can be caused by a fear of recession or inflation, and each fear causes certain stocks to rise or fall. Cramer stressed the importance of going with the herd even if one feels the herd is wrong; "You're better off being attuned to the mood of the market than being right." Widespread fear of inflation creates a good environment in which to buy gold, and Cramer suggests an investor "raid the supermarket aisles and the medicine chests" when recession fears loom. 

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