When insiders buy their company’s stock at its high, it’s no doubt a bullish sign. But it’s not the only one that managers can offer. If they buy in the face of heavy short interest, Cramer said Friday, then that too could be an incredibly positive tell.
He called it “drawing a line in the sand.” Insiders are letting the shorts know that they won’t let their stock go any lower, and it often sets up a standoff that the managers can win. Think about it: Who would know the business better than they do? Soon enough the shorts catch on, and they race to cover their bets. This in turn generates a huge demand for the stock, sending the share price higher.
Remember, short sellers first borrow stock and sell it on the market in hopes that the price will drop. If everything goes according to plan, they buy it back at a lower level and collect the difference. The problem, though, is if the share price rises. In this case, a “short squeeze” ensues where the shorts scramble to buy back the stock in order to stem their losses, and this causes the share price to rise even more. It’s this move higher that Cramer wants viewers to take advantage of.
Buybacks are another event that can catalyze a stock. Cramer said that many share repurchase plans can be a waste of company money, but they’re a good reason to give a stock a second look if managers are using the buyback to rebuff short sellers.
A note of caution, though. Thanks to Christopher Cox’s tenure as Securities and Exchange Commission chairman under the last Bush administration, short sellers these days wield an enormous amount of power. Gone are regulations like the uptick rule, which forced traders to wait for a stock to tick up in price before selling it short. And this lack of supervision, Cramer believes, contributed to the crash of 2008, which saw short sellers relentlessly hammering down a number of “too big to fail” financial companies.
So while overreaching shorts can offer great opportunities when insiders are buying, the rules right now favor the shorts – even if they’re wrong about a company’s prospects.
In short, “Don’t underestimate the amount of damage the shorts can do,” Cramer said.
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