Jim Cramer's First Commandment of Trading

"Don't turn a trade into a bad investment... Or else!"

The first commandment of trading according to Jim Cramer is, "Never turn a trade into an investment.".  There is a difference between a stock trade and a stock investment.  A stock investment happens when you buy a stock for the long term because you believe that the companies fundamentals are solid and better then the other stocks that it competes with.  When you invest in a stock you should believe that your stocks value will rise over time.  On the other hand a trade is when you buy a stock because you believe that there will be a catalyst or event that effects the stocks price that is going to take place in the near future.  This catalyst will drive the stock's price higher allowing you to sell the stock for a trade profit.

It is very important to understand the catalyst for a trade.  The catalyst is the reason that you think the stock will go higher in the near term.  From yesterday's post:  Examples of catalysts are legal rulings, election results, quarterly earnings reports etc.  You may decide to trade Lowes stock because you have noticed a large increase in business at Lowes in your area.  You may ask some family that you have in a different area of the country if they have noticed a lot of people in their area frequenting Lowes also.  Plus you see a story on the news reporting that a lot of people are doing home repairs.  So you may feel that Lowes will have great quarterly earnings that beat Wall Street Analyst expectations.  In that case you could execute a trade by purchasing shares of Lowes stock before their next quarterly report with the expectation that when they beat their earnings estimate their stock price will rise dramatically.  In this case the catalyst for the trade is the release of the quarterly report.

Two possible outcomes for this trade include the following.  Lowes could report a terrific quarter sending the stock price significantly higher.  Then you would finish your trade by selling your shares and making a quick profit.  On the other hand Lowes could miss quarterly earnings estimates and the share price could tumble.  At that point you would need to exit the trade.  No matter what happens you must have an exit strategy for a trade.  If the stock goes up you take profits, if it goes down you minimize your losses and sell the stock.  (Don't sell into a panic or a free fall in the case a trade turns against you.  Wait for the stock to show a bit of strength before you sell it unless the losses are minimal.).  Either way you end up selling the stock when you execute a trade.  Do not let a bad trade turn into a worse investment!  That is a sure fire way to lose money.