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Cramer's 'Mad Money' Recap: Playing a Short-Term Rally

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(This program last aired Aug. 31, 2012.)

NEW YORK ( TheStreet) -- There's nothing worse than watching the averages soar while your portfolio barely moves, Jim Cramer told "Mad Money" viewers Friday. He dedicated the show to the rules for taking advantage of a short-term market rally.

Cramer said that knowing how to approach a rally will definitely make you a better investor because, while it may seem like your portfolio can run itself during a rally, in fact, rallies are the perfect opportunity to lighten up on your positions and take profits.

"You don't have a profit until you sell something," Cramer reminded viewers, which is why he always encourages investors to sell into strength, then use market weakness as an opportunity to buy back in at a lower price. Hang on too long, cautioned Cramer, and risk watching your profits evaporate before your eyes.

The key to approaching any rally, said Cramer, is to look at it with some pessimism, something that shouldn't be hard after years of being held hostage by the financial woes of Europe. Never let "rally euphoria" lead to complacency, he said, because profits can disappear just as fast as they appear.

Don't Panic!

People always want help when the market sells off, Cramer told viewers. While it's normal to panic in the face of losses, Cramer said investors need to reject he notion that people only need help when the market is lousy. Mistakes happen on the way up as well.

Cramer said his first rule for rallies is to be tough on your portfolio during big "up" days. The only time to scrutinize more is in the middle of a big decline with seemingly no end in sight. "Assume everything is guilty until proven innocent," said Cramer, and make each of your holdings prove why it's worth holding.

It's only natural to develop a love affair with stocks that are making you money. After all, they've made you wealthier so of course you're going to want more. But in reality you should like your winners less, said Cramer. For one thing, they've just gotten more expensive and therefore less attractive. When the downside outweighs the upside it's "end of story," said Cramer.

To help sort out the holdings in your portfolio, Cramer said he likes to rate each stock on a scale from one to four. Ones are stocks he'd buy at the current price while twos are stocks he'd buy on a pullback. Threes are stocks to sell at a higher price and fours are stocks to sell now.

Cramer said using a simple rating system allows investors to remove emotions from the rally equation. As the market moves higher, stocks that were a one become a two, stocks that were a three become a four. If the fundamentals haven't changed, Cramer concluded, that stock you're in love with may have just gotten too expensive.

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