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Why 'Buy and Homework' Is a Better Strategy

Let’s be clear – what exactly is a top? It’s when a stock or the whole market reaches some price and then comes tumbling down. If you try to ride out a top, you could lose all your gains and then some.

Sooner or later every stock, every market, reaches a point where it can go no higher, and, in fact, starts going a whole lot lower, maybe for years. This is historical fact. If you own a stock and that stock keeps chugging along, going higher and higher, at a certain point you know you should get out. No one wants to give up on a moneymaker, but you have to be honest with yourself – the stock’s going to hit a peak at some point, and it’s best to be prepared for it.

Don’t approach this like the Street. When Cramer was working for Goldman Sachs, the graybeards on staff would tell him not to sell until a stock had been downgraded. But what’s the point of that? Wait until the stock has already come down? Forget it.

One of the best ways Cramer uses to spot a top on the horizon is when the bears start disappearing, when all the analysts who cover the stock have upgraded, when there are no, or very few, sellers left. When there’s no one left to convert from seller to buyer, or people on the sidelines to cajole into the game, then that means everyone who wants to own the stock already does. At that point the buying stops, and with no more buying, you’ve got a top – time to sell.

Another way to watch for a top is to track the competition. Home Gamers, you have to watch more than just your stock when doing homework – you have to watch the whole sector. You need to make sure there aren’t any up-and-comers ready to gobble up market share and send your stock hurtling down. Otherwise, Cramer practically guarantees you’ll get blindsided, your stock will hit a top, and you'll lose money.

Bottom Line: We don’t like to think about tops, but we know they exist. Two of the best ways to see them coming are by keeping any eye on the analysts – if they all get too bullish, you sell – and by watching out for competition. Be sure to check out the next post for Cramer's three other rules for spotting tops.

Questions? Comments? madmoney@cnbc.com

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