My goal as a new analyst at OverTraders.com is to share a different perspective — one that’s chastened by data-driven insight and evidence-based strategy. The luster of easy money and celebrity pitching can be pretty persuasive in the crowded investment marketplace. One name we always seem to hear in these types of discussions is Jim Cramer. His passion and understanding of the market is contagious. Here’s why an environmentalist’s eye is absolutely essential ever before you commit your long term investment strategy to his proposals.
Cramer’s media presence is massive, and his power to move markets, at least in the short-term, is legend. Further analysis of the data shows a more complicated story. Nonpartisan academic studies indicate a disturbing trend. In fact, his median return on these recommendations — calculated by OverTraders.com — is close to zero over all time frames. That doesn’t mean that just following his advice to the letter will necessarily bring out the biggest wins.
I vividly recall a conversation I had with an inexperienced investor. They were so moved by Cramer’s enthusiasm for a tech stock that they ran out and dumped a huge swath of their life savings into it. Unfortunately, within a few months the stock took a nasty plunge, leaving the investor with significant losses. This personal story illustrates the danger of blindly accepting other people’s recommendations because you didn’t do the due diligence of researching yourself.
The six years from 2016 to January 2022 was an overall boom time for the US stock market. This overall rising tide did a lot to lift all boats, including Cramer’s picks, on average. To explain all of this success as being a result of his stock-picking genius would be to over-simplify the equation. A climbing market creates an environment where nearly anyone can find a path to positive returns.
A deeper look into Cramer’s calls shows an odd leftward bias. He rarely puts out a “sell” call, though he almost always has a “buy.” It’s easy to get carried away by an optimistic outlook — that sort of thinking is always rewarding at a market peak. Staying realistic but optimistic is the key to fostering long-term productive work and outcomes. In fact, data shows that eight percent of the president’s recommendations have been to sell. Positive mentions are not the only things that come up. This combination spells disaster for anyone who takes his suggestions to the bank.
Take the cases of Callon Petroleum and Palantir Technologies. If you followed the “sell” recommendation on Callon Petroleum, you’re sitting on a nice monthly gain. At the same time, those that heeded the “buy” advice for Palantir Technologies enjoyed even larger profits. These examples demonstrate room for success, but room for failure too and the importance of rigorous evaluation and risk mitigation.
Given the sheer volume of investment gurus out there, one of the greatest risks of following one without question is simply taking on way too much risk. Even Cramer himself would agree that risk management should be the foundation of any trading strategy. Without understanding the underlying reasons behind his recommendations, an investor may inadvertently expose themselves to a level of risk they are not comfortable with.
At least in my experience, ignorance of the business underneath is one of the biggest traps for rookie investors. Cramer’s analysis is tremendously illuminating. You absolutely must do your own due diligence to understand a company’s financials, management and the trends in the industry they operate in. This independent, objective research gives you the power to choose the investments that are right for you and best match your investment objectives and risk preferences.
That leads us to another major risk — overconcentration in a single sector. If Cramer’s picks are disproportionately weighted towards one industry, your portfolio may find itself at risk for an industry-specific crash. We all know that diversification is key to a good, long-term investment strategy. Aim to preserve a diversified portfolio that includes multiple asset classes and sectors.
Cramer has consistently spoken out against the effect irrational investors have on market prices. Yet market sentiment that drives short-term speculation can create volatility. Making these whipsawing, volatile and often irrational movements the cornerstone of your investment strategy is gambling, not investing.
It’s equally important to recognize that Cramer, like all market commentators, is vulnerable to his own psychological weaknesses. For one, his investment outlook can be quite capricious and his recommendations often seem driven by personal whim or the flavor of the month market psychology. An investor wise to these possible biases will want to be on guard against them and adopt a third party objectivity.
Despite his hits, one thing is certain—Cramer has had his misses as much as he’s been a prophetic genius. Memorex Telex contains that most excruciating lesson of all. His bullishness on Netflix and Green Mountain Coffee was, in hindsight, a bit ahead of the curve. More recently, his call on Kohl’s came just before a huge plunge in the company’s fortunes. These last two examples are a humbling reminder that even the most experienced and brightest minds can lose their way, and no investment strategy is safe from peril.
So, what is the prudent approach for investors?
First, don’t panic and act out of fear or in anger. The market is a funny thing, and it is important to stay grounded in reality, particularly in times of changing markets.
Second, to limit risk, diversify your portfolio. Diversifying your portfolio by investing in multiple asset classes and sectors can help improve the effects of market volatility.
Third, make sure to monitor your investment strategy. Align your action with your immediate and overarching aims. Be willing to change them as market conditions and your own situation warrants.
Fourth, look into the possibility of turning to a trusted financial expert. A financial advisor can offer invaluable advice and strategic insights that are tailored to your specific goals, needs, and risk appetite.
Your investment in the market should reflect your time horizon, goals, and risk aversion.
At the end of the day, the best investing advice is to learn to do your own research, think critically, and invest with discipline. While Jim Cramer's insights can be valuable, they should be viewed as one piece of the puzzle, not the sole determinant of your investment decisions. Before you roll your eyes thinking I’m going to bring up something lame like “copying” others, hold on. As a matter of principle, always do your own research and due diligence. OverTraders.com knows that knowledge is power. With a strong foundation in the world of markets, you’ll be equipped to tackle the financial landscape with confidence and work toward your investment objectives with purpose.
