A Playbook for Selloff

From Jim Cramer's Mad money show:
http://www.thestreet.com/_tscnav/funds/madmoneywrap/10396256_1.html

1) Have Cash Available
To take advantage on down days, investors are going to need cash. Because corrections are inevitable, it's important to have cash available to buy stocks when they get cheaper.

• Never have less than 5% cash.
• When market is up huge, have as much cash as possible around 20% to wait for opportunity to buy on down days.

2) Circle the Wagons
Cramer suggested that investors make a list of stock they own and every stock they're considering. Stocks can be divided into four categories and "Rank them every Friday," Cramer said. "Wait until you have a free moment to catch your breath." It doesn't pay to try to rank stocks in the heat of the trading day.

• The first stocks are "ones you're trying to back the truck up on. These are the stocks you plan on buying, period. They're your serious conviction names."
• Second are the ones that are buys, but only if they come lower.
• Third are stocks "you own and would sell, but only if they rally 5 to 7 percent."
• The fourth set of stocks is made up of "stocks you own and want to sell right now," Cramer said.
• During a bad day, investors should shift their capital to stocks on the first and second lists. The money to buy those stocks will come from selling the stocks on the third and fourth lists, Cramer said. When the market gets hit hard, investors should throw out their worst stocks and "circle the wagons" to buy the best stocks.

3) Where to look for opportunities

Stocks that have pulled back from their highs.

The first place to look for opportunities, according to Cramer, is in stocks that have pulled back from their highs. Stocks that are hitting new highs tend to be more expensive, but when they get knocked off the new high list, they become more attractive.
Of course, some stocks coming off their highs will be going lower for good reasons, so it's important to choose wisely. "You'll have to use your discretion for each individual stock," Cramer said.
The rewards of picking correctly, though, are great, as stocks that are off their highs in a correction "recover hardest and fastest from the carnage unless again they are the reason for the carnage," Cramer said. Investors should have at least one stock that's off its high in their selloff playbook, so when the decline comes they can take advantage of it.

Dividend that becomes a whole lot more attractive as share price decreases

The second kind of stock to shop for during a correction is one with a dividend that becomes a whole lot more attractive as share price decreases, Cramer said. "A market correction will give you higher yields," he added.
"I know dividend investing isn't sexy," Cramer said, but "no one ever woke up unhappy" the morning after buying a stock that made them money. "You want stocks that are practically guaranteed to put money in your pocket."
Again, be careful, Cramer urged. A good rule of thumb is to look at a company's earnings. If the expected earnings are at least twice the size of the dividend, the stock is a safe bet.

Two Kinds of Selloffs

Cramer said that a selloff is "a real sustained period of negative action." A correction can be caused by by inflation or a recession, and the fear of either can spur a decline.
Cramer urged viewers: "When the market takes a 10% hit in under a month, don't get clever." No one can outsmart a down market. "Follow that darn herd," he said, at least for the duration of the negativity. "You're better off being attuned to the mood of the market than being right."
"When the Street thinks inflation is a problem, certain stocks go up. Most stocks go down. When the Street thinks recession is a problem, certain stocks go up. Most stocks go down," Cramer said. It doesn't matter whether the Street's view is correct. Investors shouldn't fight the sentiment.

1) Inflation-fueled selloffs
During inflation-fueled selloffs, investors should buy gold or mineral stocks, which are anti-inflation plays. These stocks should preserve their value or go higher, Cramer said.

2) Slowdown selloffs
During slowdowns, "raid the supermarket aisles and the medicine chests." Soft goods and diagnostics are good bets for a recession, Cramer said.
"It's important that you not confuse these two things," Cramer emphasized. Buying the wrong stock during a selloff can be very painful.