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Cramer clears up the crucial difference between trading and investing

Abigail Stevenson

Investors frequently ask Jim Cramer what to do with a stock after it has had a hideous decline.

His first response is always to ask why they bought the stock in the first place.

One of Cramer's cardinal rules is to never turn a trade into an investment. If there is one thing he wants investors to take away from " Mad Money ," it is to never confuse these two concepts.

That means understanding the purpose of why you are buying a stock.

Watch the full segment here:

If you bought it for investment purposes, that could mean you should buy more. If you bought it for trading purposes, then that means you waited for a specific event to occur and should only buy it once.

Sometimes an investor will buy a stock for one reason, and then another reason happens. Then they decide to turn the trade into an investment and buy more as the stock goes down. Or perhaps the reason for the trade never happens, so they end up holding the stock.

"What's the worst thing that can happen? The answer, of course, is plenty, and almost all of it bad," Cramer said.

When Cramer wants to invest in a company, he will buy a small amount of it to start and then hope that the stock market will knock it down so that he can buy more at a better price. He loves a good market-wide correction to get a better price on buys.

Trading is exactly the opposite. He puts the maximum on at the beginning, because he believes that the data point or event is about to occur. He will never buy anything for a trade without a defined catalyst and he will never just hope it goes higher. There can be no hope in the equation when you buy a stock for a trade.

"I buy down when I am investing. I cut my losses immediately when I am trading if the reason I am trading the stock doesn't pan out," Cramer said.

So, don't fool yourself. If you know you purchased something for the purpose of trading, cut your losses quickly when it starts to go awry. Sure, there might be a time here and there where you could turn it into a long-term trade. But most of the time, you'll be on the wrong side of the trade.

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