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Cramer unveils the scariest pattern in the chart book

Key Points
  • "Mad Money" host Jim Cramer says this key stock pattern means it is time to sell.
  • This pattern scares Cramer because it signals trouble ahead for the given stock.
  • The most frightening part? This chart pattern is usually right, Cramer says.
Traders on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters

The most simple and reliable chart pattern out there is one that Jim Cramer dreads.

Unfortunately, Cramer learned not to ignore the head-and-shoulders pattern the hard way. His charitable trust bought Alcoa — which spun off its aluminum business in November 2016 under the name Alcoa and is now known as Arconic — in 2010, when the stock price was in the low teens and ultimately took a loss because it was too early to buy.

"Yes, just like a human's head. That is the most frightening pattern in the chart book," the "Mad Money" host said.

Shares of Alcoa saw a healthy run from the winter of 2010 to February 2011, rising from $13 to $17. The stock ran to $18 on the eve of its quarterly earnings report, and Cramer thought it was a fine quarter when it reported.

What worried him was that even after an initial positive reaction, the stock dropped. Several days later, however, Cramer assumed it would take out its $18 level and went back to buy more.

But Cramer was wrong — extremely wrong.

What the "Mad Money" host did not realize is that the fluctuation in price had traced a perfect head-and-shoulders pattern.

It turns out that during the time when the head-and-shoulders pattern was forming on Alcoa's chart, Europe and China's markets started to slow down, sending aluminum into a glut.

Ultimately, former CEO Klaus Kleinfeld could control his own company but not the price of the commodity itself.

On the other hand, if a head-and-shoulders pattern signals trouble ahead, then the inverse head-and-shoulders formation signals the opposite — a chance for glory.

"The key with this pattern is the neckline, the line that connects the high to the two shoulders. When a stock breaks out above that line it tells a technician that you are about to witness a big move higher," Cramer said.

At the end of the day, patterns matter. So when you see a head-and-shoulders pattern, no matter how confident in the stock you might be, Cramer believes you should sell. And when the reverse head-and-shoulders develops, then you should consider buying.

That is just how powerful these moves are. The chart is right more often than most would ever think possible.

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Cramer unveils the scariest pattern in the chart book

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