There’s another scenario where insider buying is a great sign to buy. When a stock has a heavy short position, it means there are a lot of people who have serious conviction that the stock is going lower. Shorting is essentially the opposite of real investing. Instead of buying low and selling high, shorts sell high and buy low.
It takes more effort and certainty to short a stock than it does to buy for the long term. When you’re short, the potential downside is infinite because a stock can always go higher. But when you’re long, the downside ends at $0. And when there are a lot of shorts – and a stock suddenly gets some good news – you get the all-important short squeeze. The shorts have to buy, and when they do it all at once in a panic, the stock will surge because of all the new demand.
A heavily shorted stock, in combination with insider buying, often makes for an explosive combination, Cramer said. If a stock has a big short position and then the people who run the company start buying up shares, you can bet there’s going to be a short squeeze. While shorts are usually smart, they aren’t smarter about the business than the people who actually run it. If a lot of people are shorting a stock, betting it goes lower, and management is buying it, you’re going to want to side with management, Cramer said, and ride the short squeeze higher and higher.
Bottom Line: Insider buying plus a heavy short position equals buy.
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