Cramer said executives can sell company stock for all sorts of reasons. But buying, especially in large quantities, should be a clear signal that execs are highly confident in their outlook and are putting their own money on the line to prove it.
This is especially true of stocks at or near the 52-week high list, said Cramer. If a stock is already at sky-high valuations, and insiders are still buying, that is a powerful endorsement. There is nothing more telling than when an insider backs up the truck for his own stock when its sitting at a high.
Avoid paying too much attention to small, token purchases, Cramer cautioned. Look for only large, meaningful insider purchases. Sometimes execs want to make it look like they have confidence in their stocks. But when they actually do have conviction, that's the time to follow their lead.
Continuing on the insider buying theme, Cramer's next trick is to look for a special type of insider buying, one that involves a stock with a huge short interest.Cramer explained that short-sellers must have a lot of conviction in order to bet that a stock is heading lower. The downside of shorting a stock is infinite, while going long on a stock limits losses at zero. Short-sellers also risk a short squeeze, a bit of good news about a company that sends shares high enough that those short the stock are forced to cover their positions. The dynamics of short-selling makes insider buying all the more interesting, said Cramer. When lots of people are betting against a company and an executive starts buying, Cramer said that's like drawing a line in the sand and saying, "Our stock goes this low and no lower." Cramer said any time investors see a large short interest coupled with meaningful, not token, insider buying, they should perk up and start the research immediately. While short-sellers are smart people, they often know less than those in charge of running the company, noted Cramer. Cramer offered a caveat to betting against the short-sellers, however: Avoid hot-button stocks where the short interest is simply too large to overcome. At the height of the financial crisis in 2008, Cramer noted that short-sellers were able to overrun many bank stocks, thanks in part to the removal of protections like the uptick rule, which helped to slow these so-called "bear raids."
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