Every week Jim Cramer works with technicians in "Mad Money's" Off The Charts segment to look for chart patterns that can predict the next big stock moves. While Cramer is certainly not a chartist, he understands technicals play a vital role in understanding if a big move is the real deal.
"Why do charts work? First, you must consider them as if they are footprints at a scene of a crime. These footprints trace out what big money managers might be doing with their buying and selling of stocks," the "Mad Money" host said.
The second reason to care about charts is that Cramer finds there is a remarkable self-fulfilling nature of charting stocks. Some of the best investment ideas can come from chart inspired brainstorming sessions — though Cramer thinks that the best way to produce results is with a careful melding of both fundamentals and technicals.
A good technical analysis means being able to find the indicators that will help to determine the overall direction of the market, especially since so many stocks are influenced by the stock futures.
What indicators does Cramer watch for?
Sometimes technicians start by comparing the chart of an individual company to the chart of an average to determine the legitimacy of a move. This is what is known as confirmation.
For instance if the Dow Jones Industrial Average hit a new high, historically it is not sustainable unless the Dow Jones Transportation Average also hits a high, or confirms the breakout status of the Dow itself. So, if both the industrials and the transports hit a new high, Cramer considers the move to be one he can bless as being legitimate.
"I like to see all of these indices move up in sync before I truly bless a market move. You get all of these indices rolling higher, and you have to put the maximum amount of chips on the table," Cramer said.
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The inverse is also true. If there is a move up without confirmation from a majority of the indices, then the whole rally could be fake and cannot be trusted. Cramer saw this occur right before the Great Recession, when there was no participation from the financials, retail and tech.
Additional internals that Cramer looks at are advances and declines, as they will indicate if a rally is too concentrated. He likes to have a market with good participation from many different groups. He also looks at the new high to new low ratio, since it isn't easy to get on the new high list.
"You may not be a technician but you need to know what the charts are saying and you need to know how to read the internals to verify a real move or a phony one," Cramer added.