Mad Money

Cramer Remix: Everyone adores this stock, here’s how to get in

Key Points
  • "Mad Money" host Jim Cramer went over the key chart patterns all investors should keep in mind.
  • Knowing when stocks are overbought or oversold is key to understanding how to play them, Cramer said.
  • The "Mad Money" host also shared the lessons he learned from two reliable, albeit scary, stock patterns.
Cramer Remix: Everyone adores this stock, here’s how to get in
Cramer Remix: Everyone adores this stock, here’s how to get in

Despite domestic political turmoil or international trade tensions, CNBC's Jim Cramer knows one thing to be true: "If you put up better than expected numbers, your stock goes higher."

The "Mad Money" host has repeatedly talked about stocks that Wall Street underestimated that ended up soaring after reporting strong quarterly earnings numbers.

"Analysts and investors were just too darned pessimistic, or too political, which amounts to the same thing, so they kept being blindsided by everything that's going right," Cramer said.

With this earnings season coming to a close, Cramer turned to his weekly game plan to see which companies reporting earnings have the capacity to beat the market's expectations.

Lululemon reports on Thursday. Cramer's only reservation about this stock? Everyone else thinks it's great, too. "If Lulu goes down before it reports, I would pounce. This is a go-to name on weakness," he said.

Read Cramer's full game plan here.

Finding a bottom

Michael Nagle | Bloomberg | Getty Images

Additionally, when a chartist sees that trading volume has grown but the stock has not gone down, it often means that the stock has finally found its floor and is now safe to buy. In other words, the buyers' power to determine the direction of a stock is finally equal to the sellers'.

Chartists also look at the advance of a stock, which happens when the stock takes out its resistance overhead.

Rather than simply looking at a stock's closing price and graphing it against the previous day's close, technicians use what is known as a moving average to better represent a stock's movement. They calculate the moving average by taking a stock's closing prices over a period of time, adding them up, and then dividing by the number of days in that period.

Tracking volume

Getty Images

"Typically, when a stock gets overbought, it is ripe for a pullback because overbought stocks, ones with many buyers reaching to take in supply, tend to snap back after they have gotten too far away from their longer term trend line," Cramer said.

Investors can determine whether a stock is overbought or oversold by charting the ratio of higher closes, also known as the relative strength index, or RSI. This is a momentum oscillator that measures the direction of a given stock and the velocity of its move.

To find moments in an individual stock's trajectory where its strength stands out — a potential sign of a pending move or change in momentum — Cramer matches the stock's RSI to something else, such as the relative strength of its sector or a wider index, and then measures the past price action.

Scary patterns

Brendan McDermid | Reuters

But the most simple and reliable chart pattern out there is one that Cramer dreads.

Unfortunately, Cramer learned not to ignore the head-and-shoulders pattern the hard way when 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.

Another chart type that Cramer uses is called the cup-and-handle pattern. In fact, he has relied on this pattern to stay in stocks that he might have otherwise sold.

A cup-and-handle pattern is one that resembles a cup with a handle. The cup creates a 'U' shape with a downward drifting handle.

Cramer learned the lesson of the cup-and-handle opportunity in the stock of Domino's. He was thinking about selling the stock when chartist Ed Ponsi set him straight and told him not to.

Ponsi pointed out that Domino's had reached a pivotal moment and was getting ready to launch into a bigger move. Sure enough, Ponsi nailed it, and Domino's proceeded to double and then some.

It turned out that while Cramer was nervous about the stock, it was actually consolidating and getting ready to power higher as the company embraced new technology and broke into digital ordering.

"Technicians and fundamentalists can co-exist," Cramer concluded. "Make peace with them both, and I bet you will make a heck of a lot more money than if you are blind to one or the other and, certainly, to both."

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