Jim Cramer's Real Money: Sane Investing in an Insane World

If you look through my wallet, you will find all the things that everyone carries: license, credit cards, pictures of my wife and kids, and some cash. But if you look deeper, in some of the crannies, you'll find two things no one else has: my first pay stub, a tattered, faded beauty from the Tallahassee Democrat newspaper from September 1977, and a snippet of a portfolio run from the lowest day of my life, October 8, 1998.

I keep these talismans with me wherever I go, because they remind me why I got into stocks and why I had to stay in stocks no matter what, because the opportunities are too great not to be in them. The $178.82 I made that first week as a general assignment reporter in Tallahassee serves as a reminder to me that a paycheck is almost never enough to make a decent living on and to save up for the necessities of later life. That torn and bedraggled stub, with its $30 in overtime and oversized take by the federal government, keeps me honest and reminds me where I am from, how I never want to go back there, and how hard work at your job isn't enough to make you rich. You have to invest to make that happen. If you invest well you should almost always be beating the return you get on your day job.

The other smudged rectangle of paper in my wallet, the one that obscures the right-hand corner of my wife's picture, bears a series of cryptic numbers: 190,259,865; 281,175,544; and 90,915,674. The last number has a big black minus sign right after it. That's a cutout from my daily portfolio run on the most disastrous day my hedge fund ever had, October 8, 1998, a day when I was down $90,915,674 -- that's right, more than $90 million on the $281 million that I was supposed to be managing. I had "lost" almost half the money under my management in a series of bets in the stock market that hadn't yet paid off, to put a positive spin on an unmitigated decline. At that moment, everyone -- my investors, my employees, the press, the public -- everyone had written me off, except for my wife, whom I had worked with for so many years and who knew never to count me out. "You've had it, Cramer, you are gone," the collective brokerage chorus told me.

Not two months before I had been on the cover of Money magazine as the greatest trader of the era. Now I was wondering whether I could survive the year. With just two months left, I had to find a way at least to make back that $90 million if I wanted to stay in a business that I had thought I was born for. Most hedge funds don't come back from those kinds of titanic losses.

Using the very same techniques and tactics I will describe here, I methodically made back all of the money I had lost to date that year, and by December I had returned to a slim profit for the year. I finished up 2 percent, a $110 million comeback in less than three months. I averaged $1.4 million in profits every single day. Yet I still waived my management fee of $2 million because I didn't think I deserved a penny given how I had almost broken the bank. I still don't think I deserve to get paid for a comeback, because I dug my own hole by not following my disciplines and my rules, by succumbing to a lack of diversification and to inflexibility, those two assassins of capital.

That snapshot of how close I came to failure reminds me how important it is to stay investing and trading stocks no matter what because they are just too lucrative to stay away from for any long period of time. It also serves to remind me of how humbling this business is and how important it is to adjust course, for I had been sloppy and blind to a changing market during that catastrophic year. Had I not been flexible and willing to change strategies, I would never have come back.

In the very next year after my near-cataclysmic debacle, I made more than $100 million. The following year I made $150 million, again using the same rules and techniques I will describe here. I had plenty of help in the $100 million year: the market was terrific, easy, almost straight up. But in 2000, the biggest year, the $150 million year, the market peaked and crashed, yet I still profited supremely because you don't need the market to go up to make money. The fact that almost every mutual fund lost money in my biggest year is not a statement about my stock-picking prowess but evidence that if you are disciplined, use common sense, and take advantage of all the devices and tools out there, you can profit no matter what. Or, as I say at the end of my radio show every day, "There's always a bull market somewhere" that you can make profits from.

But you have to stay in that game to find that bull market. In the end, when all else fails, "Stay in the game" is the only mantra that's worth repeating. It keeps you from picking stocks that can wipe you out. It keeps you from speculating on situations that are worthless. It keeps you from borrowing a lot of money, known as margining, and hoping that stocks will make a magical move upward. It keeps you from wallowing in worthless penny stocks. It keeps you from trying to make a killing in tech. And it stops you from averaging down on bad stocks, because stocks aren't like parents when you get lost at the mall; they don't always come back. Staying in the game is the ultimate lesson. How do I know this? Because it is what I have done. I have been able to make big money when big money could be made because I didn't get discouraged or fed up or desperate when times got tough. I didn't do anything illegal or silly or unethical to stay in the game because I knew that when the game eventually turned, I would be there to pounce on what was to be gained. Staying in the game makes sense rationally and empirically because, over the long term, we know stocks outperform all asset classes. The reason more people don't get rich with stocks, though, is that people can't seem to stay in long enough to win. They get bored, tired, frustrated, defeated, or reckless. They get discouraged. They get beaten by the unnerving and jarring and humbling process not of investing but investing successfully.

My methods are designed to keep you from getting discouraged and quitting. Staying in the game is key, it is everything, and if you can't stay in the game then you have failed. And I have failed. I can't let that happen.

But before I take too much credit for the system and methodology I used to keep me making money, I have to give credit where it is due, to my wife, Karen, the woman the Street called the Trading Goddess for her manner and her proficiency in managing money and barking orders to dozens of brokers and traders. Karen was a professional institutional trader before I met her. She was responsible for taking me to the next level. She took a kid who had an eye for spotting undervalued and overvalued stocks, then she grafted on a set of rules, all of which are included in this book, that have seen me through the darkest hours and allowed me to outperform even when I don't have a great set of stocks on hand. She is like a master card player who can turn a good hand into a great one with a couple of tosses and a keen sense of what's in the deck. In fact, on the day that my portfolio "run" dripped with $90 million in red ink, she had to return to the office to reinstill the rules and disciplines that I had forgotten in the three years since she had retired. She again drilled them into my head, so they now tumble out here almost by rote.

Mrs. Cramer's Rules, the Rules of the Trading Goddess, make up a large portion of this book. Like me, Karen had no formal business school or accounting training. Like me, she lived from paycheck to paycheck until she found her true calling, making money in the stock market from scratch. Unlike me, she had no fundamental knowledge of how business worked or how to read a balance sheet or how interest rates control what you will ultimately pay for a stock. She always regarded those skills as overrated. What she understood was discipline and skepticism: the discipline to cut losses and run winners, and the skepticism to see through the hype that surrounds us on Wall Street. She understood better than anyone I have ever met that stocks are just pieces of paper representing shares of companies and no more than that. She knew that you could have conviction about where stocks could go and how high they could go, but it was only discipline that saved you when things didn't work out the way you thought, and she knew that things don't work out the way you think they will far more often than you would like to believe. Sure, the pieces of paper we trade are linked, albeit loosely, to the underlying entities that issued them, but in her eyes it was always important to recognize that everyone, from the media to veteran Wall Streeters, places too much importance on this linkage, which is frequently severed by rumors, by larger market forces, and, of course, by short-term imbalances in supply and demand -- all of which can be gamed effectively. Occasionally stock prices are linked irrationally to the high side, as in Japan in 1988-89 or in this country in 2000, and just as occasionally they are linked to the low side, as in September 1982, when the great bull market began; in October 1987, after the stock market crash; and in October 2002, the most recent important bottom that is restoring wealth through equity appreciation in this country. Karen taught me to spot these tops and bottoms, formidable skills that I know I can teach you. I spend considerable time fleshing out those top- and bottom-calling skills in this text so you can do the same without me.

The Trading Goddess also taught me the difference between investing and trading, and how not to confuse them. Karen was -- and I remain -- an opportunist, one who is not bound by any particular investing philosophy beyond the need to adjust to the vicissitudes of a turbulent market so you are not knocked out of the business before the good times return. Callers and e-mailers are always asking me if I am a trader or an investor. I always respond the same way: what a stupid and false dichotomy.

In the interest of putting this question to rest forever, let me tell you up front why the trader/investor distinction makes no sense. This is not pro football, where you play offense or defense, where specialized skill sets predominate and no one is a generalist. Managing your own money is like playing hockey, where everybody has an opportunity to defend and to score and everybody is expected to take that opportunity. Sometimes stocks are making radical moves in days, as they did in the 1999-2000 period, and you have to capture those moves. If you frowned on those opportunities because they were too "trading oriented" or because you only like to buy "value," you might have missed some huge profits. If you stayed dogmatic, dug in your heels, and insisted on owning overvalued stocks that had already made great moves, you could give it all back. Both of these so-called "strengths" are actually weaknesses, inflexible weaknesses that will doom you to substantial losses at various points in the cycle.

Critics of mine dwell on my bullishness in December 1999 and January and February of 2000, the peak of the last bull market, or the bubble, as some insist on calling it. But the leaps stocks were making in that contained time span have not been and may never be replicated again. In that market the goal was to make those trading gains and go home, as I did with my March 15, 2000, RealMoney.com piece saying to take things off the table, four days after the exact top in the NASDAQ. Rather than feeling guilty about some who stayed in too long, I prided myself in recognizing that the market had changed for the worse in the spring of 2000, after the greatest run of all time, and you had to switch direction, no matter what your previous pronouncements and beliefs had been. You had to stay flexible to be conservative, to be prudent, to be commonsensical and keep your gains. Wall Street gibberish about being "in for the long term" or "only interested in stocks that trade for less than their growth rate or their book value" is just plain recklessness. You have to be willing to change your mind and your direction. Nowhere in the commandments of investing is it written "One shall not change one's mind even if it may be wrong." Businesses change, they become good, they go bad. Markets change, they become good, they go bad. You can't be blind to those changes without losing money or risking being blown out of the game. But you must swear to stay in no matter what. It's not flip-flopping if you like WorldCom when the business is good and hate it when the business goes bad, even though I was accused mightily of flip-flopping, for example, when I tossed aside WorldCom in the $80s after owning it for more than five years. Had I not "flip-flopped" and booted the stock to kingdom come, I might have lost everything I had made in that stock and then some. You must roll with the punches of investing, bobbing and weaving when the underlying businesses falter or fade.

We all like to think of ourselves as conservative investors, but one of the Trading Goddess's most endearing and enduring traits is to recognize when buying, instead of staying in cash, is a conservative strategy and when holding, instead of selling, is the riskiest strategy of all. We'll explore in another section the arsenal of both short- and long-term tools and of using the downside of the market to make money, because, again, that can be the most conservative style available.

Most important, the Trading Goddess taught me to be unemotional and commonsensical about the direction of stock prices. While sports analogies help the business come alive, we can't root for stocks and stick with the home team. There is no home team. While dogma may pay in politics, it's a killer in stocks. While religion is important, hope and prayer are best left elsewhere when it comes to your money. They aren't valid here. While science has made tremendous strides in hundreds of areas of life, the stock market is not a science. It is just a humbling collection of pricing decisions involving the supply of equities and a level of demand mitigated by greed and fear, two animalistic, psychological components. Those who try to quantify it, measure it, and use mathematical formulas to tame it will in the end be chewed up and eaten by it, as the biggest gang of Nobels under one roof, Long-Term Capital Management, a moronically reckless hedge fund, showed when it lost billions and went belly-up in 1998. There are forces and emotions that determine how markets function that are not susceptible to academic logic. Often to figure out how that market is valuing things we have to go outside the balance sheet and income statements, because the emotions of the market can blind you if you are constrained by those. If we simply limit the debate over how stocks get valued to price-to-earnings multiples or price-to-book valuations (don't freak out, I'll explain those, too, in a way that you will at last understand), the market will often seem completely and utterly full of baloney and impossible to understand. But I will teach you how to make sense of all the markets we have seen, how to understand the underlying patterns, and how to know when to avoid stocks or to short them, and to know when the sages and pundits simply can't be trusted when they say, "Stay away, the market's too dangerous." In still another section of the book I will present my biggest mistakes, with hysterical and humbling simplicity, so you will never make them. As I like to say, I've made every mistake in the book, so you don't have to make any. I am your laboratory. I have done the failed experiments and can show you the results that will keep you from doing them. I detail them here in ways that will make you remember when you are about to make similar costly errors so you stop before the red ink cascades through your portfolio.

Yes, stocks are pieces of paper, but they can be bought and sold with a level of emotionless precision that I can prep you for that will work in any kind of market. Broom the dogma, cultivate the discipline, open your eyes, and let's check out the basics in a way that contains -- heck, that busts -- all the Genuine Wall Street Gibberish that clouds so many minds trying to fathom why stocks go up or down every day.

Copyright © 2005 by J. J. Cramer & Co.