Jim Cramer has decided to reveal the method to his madness. He's opening his toolbox and arming investors with the techniques he uses to determine when a stock is just begging to be bought.
"What I am teaching you are really what I call tells — they are signals that a stock might be worth owning — that it is worth your time and effort to go through the often boring process of reading through the conference call transcripts and quarterly process," the "Mad Money" host said.
First, Cramer uses the new-high list to determine what should be on his radar. Another signal that he looks for is to buy stocks that have had a big run, along with substantial insider buying. Insider buying indicates that the people running the company believe the stock is headed higher. If they believe, you should believe, too.
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.
Read more from Mad Money with Jim Cramer
Another thing to watch for in a stock that has a lot of short-sellers is that if there are a lot of them, 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 — a move called a short squeeze.
Even better, when there is a heavy short-position on a stock, sometimes the people who run the company will start to buy shares for themselves. It is the equivalent of management drawing a line in the sand and saying "our stock goes this low, and no lower."
"This is an explosive combination, and one that often leads to a short squeeze that sends the stock much higher," Cramer said. (Tweet This)
Usually, short-sellers don't know any more about a business than the insiders who run it. So, if a lot of people are shorting a stock, and management is buying it back in large quantities, this means you need to start doing your homework. That is because you might want to side with management on that one.
Another bullish signal is when a heavily shorted company announces a huge buyback, bigger than the previous one. This is another approach that management will take to stop the short-sellers.
But be careful!
Cramer warned that short-sellers can seriously damage a stock. So don't just go out there and start buying any old stock with a heavy short balance. One general rule he uses is to buy those stocks that have a large dividend.
This is because when you borrow shares, you are required to pay the owner of the shares the dividend. Therefore, the best protection is to use the dividend as a deterrent from those who abuse short-selling.
"Insider buying plus heavy short interest can equal a raging buy, as long as you avoid situations where the shorts are determined to crush the stock at any cost," Cramer added. (Tweet This)