By Abigail Stevenson
Jim Cramer finally revealed the secret to how he picks a stock.
One of the easiest ways for the “Mad Money” host to identify stocks that should be on his radar is to look at the new-high list.
These are stocks that hit a new high in trading for the day, especially on days when the market is in bad shape. If a stock hits a new high on a down day, then obviously it has something good going for it.
When a stock hits the new-high list, it is either because it is part of a bull market, it announced fantastic earnings or the sector has tremendous sales momentum.
Cramer has one exception to his rule, which is that if you see insiders buying a stock when it is already up a lot that is a green light.
“It’s a rare thing to see happen, but in my experience it is rarer still that this method of picking stocks doesn’t work out,” he added.
When insiders are getting in on a stock, it is a great sign that they have confidence that the stock is about to take off, or that it will be long lasting.
Keep in mind that most insider trading in small quantities is meaningless. Sometimes an insider will start buying stock because they want to give the impression of confidence. That is why when there is a colossal amount of buying, Cramer wants you to take another look at the stock.
However, Cramer warned that these signals alone are not a good reason to buy a stock. At the end of the day, there is no avoiding doing the homework on a company. That means checking the fundamentals and making sure the company has a story that you can get behind.
A stock could also be a raging buy when it has heavy short selling. This refers to when investors borrow shares that they don’t own, sell them and then wait for the stock to go lower before buying them back.
Short sellers look to collect the difference between the high price where they sold, and the low price where they buy back the shares. Short-selling is an indication to Cramer that the investor who sold short really believes the stock is headed lower.
“You can think of shorting as like regular investing, only in reverse. We try to buy low and sell high. Shorts just turn that around, selling high and then later buying low,” Cramer added.
If a stock has a lot of short sellers, and all of a sudden good news comes out, the stock could surge. That is because the short-sellers then panic and scramble to cover their short positions. This is a move called a “short squeeze”.
Investors can make a lot of money by owning a hot stock with a lot of momentum. The trick to making the most money is knowing when to get out.
“The key to figuring out when interest has peaked and it is time to sell is by watching the analyst coverage,” Cramer added.
Once a hot stock has at least six analysts covering it, then the love may die down for the stock, Cramer said. That’s because it is about to be too big and too well known, and the stock cools off when everyone who was interested in buying it has already done so.
Learning how to trade around a core position in a portfolio can be an investor’s best technique to combat volatility in the market. In fact, it was one of the techniques Cramer used to become successful on Wall Street.
“This is a discipline that is incredibly useful, especially in volatile, crazy markets,” Cramer said.
Trading is all about profiting from short-term fluctuations in price, which can be caused by a catalyst or a wild market. In Cramer’s opinion, knowing proper trading strategy will make you a better investor. That is why it is so important to know how to trade around a core position.