Making money takes a little homework

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.

Excerpted from “Real Money” by Jim Cramer. Copyright © 2005 by Jim Cramer. Published by Simon & Schuster. All rights reserved. No part of this excerpt can be used without permission of the publisher.

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