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. Investors that try to ride out a top could lose all their gains and then some, Cramer said.

In Cramer's experience, 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, he said. Anyone who owns a stock that stock keeps going higher and higher should recognize that there will come a time to get out. No one wants to give up on a moneymaker, but every stock has its peak. It's best to be prepared for it.

Don’t approach this like the Street, Cramer said. When he 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, he said.

Another way to watch for a top is to track the competition. Investors have to watch more than just their stock when doing homework – they have to watch the whole sector. They have to keep their eyes on any up-and-comers ready to gobble up market share and send their stock hurtling down. Otherwise, investors can expect to get blindsided, their stock will hit a top, and they will lose money, Cramer said.

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, sell – and by watching out for competition. Be sure to check out the next post for Cramer's three other rules for spotting tops.

Jim's charitable trust owns Goldman Sachs.

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