Jim Cramer does not get out of bed at 4 a.m. every day just to dish out the hottest stock picks to the CNBC “Mad Money” audience.
He does it because he is passionate about educating investors on the ultimate insider’s perspective for the market and how to make money.
“What I’d really like to do is empower you, and that starts with me teaching you all the many tricks I use to pick out great stocks and trade them like a pro,” Cramer said.
So what does the “Mad Money” host look for when picking a stock?
One of the easiest ways for Cramer to identify the 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 it is hitting a new high on a down day, then obviously it has something good going for it.
However, that doesn’t mean Cramer recommends chasing after every stock on the new-high list. That would just be completely ridiculous. The list is merely meant to be used as a jumping off point for stocks to start looking at. Then, the time-tested method of doing your homework comes in to play to ensure that the fundamentals of the company are sound.
So, now that you know the basics of how Cramer picks a stock, what if you really, really, really want to buy a stock that is hitting a new high?
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.
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 its rise 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 if there is a colossal amount of buying, then 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.
There is also one other scenario that indicates the stock is a raging buy. That is when Cramer sees that a stock has heavy short selling, meaning investors have borrowed shares that they don’t own, sold them and are waiting for the stock to go lower before buying them back. Short sellers are looking to collect the difference between the high price where they sold, and the low price where they buy back the shares.
“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.
Why is short selling important?
Short selling is an indication to Cramer that the investor who sold short really believes the stock is headed lower. After all, the potential downside is infinite with short-selling so they are taking a lot of risk on themselves.
In order to be a successful investor, Cramer thinks that will require a lot of discipline. That discipline will pay off, as it will allow you to buy the stocks you like at lower prices and sell more shares when they are high. Trading is all about profiting from short-term fluctuations in price, which can be caused by a catalyst or by a wild market.
In Cramer’s opinion, knowing proper strategy for trading will make you a better investor. That is why it is so important to know how to trade around a core position.
What does it mean to trade around a core position? Cramer outlined the steps below:
First, pick a stock that you both like and believe will go higher in the long term. Think of a company with solid fundamentals that can stay strong when the market becomes volatile and will go higher with a little patience.
Cramer recommended establishing a position in the stock through buying in increments. Buying it all at once is just plain arrogant, in his opinion.
If you wanted to start trading on your core position, then every time the stock jumps 5 percent, you should sell 25 shares. Keep shaving a little off the top to bring in some profits. This is called scaling out of a stock, though Cramer always likes to keep the last 25 shares if he loves the stock.
So, how do you know when to sell a hot stock?
Just like when you attend a party, you have to know when it is the right time to leave. When dealing with stocks, there is a lot of money to be made by owning a hot stock with a lot of momentum. The trick to making the most money is to know when it’s time 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. (Tweet This)
A trick that Cramer uses is that once a hot stock has at least six analysts covering it, then the love may die down for the stock. 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.