Cramer Explains The Vital Difference Between Investing And Trading

Investing and trading are two terms that are not interchangeable, CNBC's Jim Cramer explained during a recent "Mad Money" show. This is an important concept for all to understand as it relates to the reasoning behind buying a stock.

A trade is placed when an individual thinks that a specific event will occur and boost shares higher in a short time period, Cramer emphasized. The underlying event typically represents the only reason why the stock was bought in the first place. Either the event happens and the stock goes up, or perhaps the timing was wrong and the stock goes down.

At this point, the individual would be encouraged to cut their losses on the stock and not turn a trade "into something it wasn't meant to be — a long term investment." The ramifications of turning a trade gone wrong into an investment in hopes of an eventual rebound are "plenty, and almost all of it bad."

On the other hand, an investment is made with no specific event or catalyst in mind, Cramer continued. If an individual invests in a stock that goes down and their long-term confidence in the stock remains unchanged the argument can be made to add to the position.

Cramer actually prefers to buy a smaller position in a stock in hopes of adding more at a lower price.

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

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