Cramer's 'Mad Money' Recap: How to Invest Like the Pros

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This program originally aired on May 1.

NEW YORK ( TheStreet) -- Individual investors can not only invest like the pros, they can beat them, too. Those were Jim Cramer's words to his "Mad Money" TV show viewers Tuesday, as he dedicated the entire show to detailing the methods to his madness.

Cramer said it doesn't take a lot of effort to invest one's own money, just a few hours a week for research, or "homework," as he so often calls it. But the results from that research will bear far more fruit than blindly dumping money into an index fund or, worse, a bond fund in a time of historically low interest rates.

Where can investors find their research? Fortunately, it's practically everywhere, said Cramer. It's on sites like CNBC.com, TheStreet, Yahoo! and others, as well as on the individual websites of every publicly traded company.

When first starting out, Cramer recommended using the 52-week high list. The new-highs list shows stocks with true momentum, said Cramer, especially in a bad market. But that does not mean that investors should just blindly chase every stock on that list. Instead, Cramer said research will still need to be done to separate the truly great stocks from the ones that are just lucky.

After researching the new-high list and picking out the winners, Cramer suggested that the homework is still not done. He told viewers to never chase stocks higher, as the market will always sell off and provide a better entry point in the not-too-distant future.

Cramer said he always advises buying stocks on weakness, then trimming positions into strength. A broad, market-wide selloff provides an excellent entry point, he concluded.

Insider Buying

Cramer's next trick for investors: Look for stocks with strong insider buying. Company executives are no dummies. If they're buying their company's stock, then maybe you should, too.

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.

Avoid paying too much attention to small, token purchases, Cramer cautioned. Look for only large, meaningful insider purchases.

Short Interest

Continuing on the insider buying theme, Cramer's next trick involved looking 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 who are 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, their ears should perk up and the research should start immediately. While short sellers are smart people, noted Cramer, they often know less than those in charge of running the company.

Cramer offered a caveat to betting against the short-sellers, however. He said to 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."

Home gamers can still find opportunities where the short-sellers have overreached, concluded Cramer, especially in stocks that pay a solid dividend, which often helps to deter short sellers, who must pay the dividend on the shares they've borrowed.

Trading

Cramer's next tip for investors: Learn how to trade. He said that learning how to trade stocks on a shorter-term basis will make home gamers better investors overall, as it will teach them many valuable lessons, especially in markets with large, volatile swings in every direction.

Cramer said his normal investment strategy would dictate that, if an investor wants to purchase 300 shares of a company, he or she would buy them in increments of 100 shares over a period of weeks or months, using broad-based selloffs as cues for the purchases.

However, a trading strategy is a little different, said Cramer. Trading around a core position dictates that, if an investor owns 300 shares, he or she would sell 50 of them anytime the stock moves higher by 3%. Then as shares retreat by 3%, an investor can buy them back on the cheap.

Cramer said that trading in smaller increments may not seem like much, but over time, the profits can add up quickly. In today's markets, where stocks can soar one day and be thrown out with the bath water the next, it likely won't take long before home gamers begin to see their trading strategies pay off.

Know When to Sell

Cramer's last trick for investors involved the critical question of when to sell a hot stock. He said there's certainly a lot of money to be made by owning a hot momentum stock, but investors have to know when it's time to leave the table or risk losing it all.

Such was the case with high-fliers Netflix ( NFLX) and Salesforce.com ( CRM), two long-time Cramer faves that fell from grace in spectacular fashion.

So how can investors tell when a momentum stock has peaked? Cramer said one thing they can look for is the analysts' coverage. For smaller, more speculative stocks, Cramer said the rule of thumb is that when a stock has half-a-dozen or so analysts covering it, the stock will begin to peter out because it has become too well known.

This was the case with Hansen Natural ( HANS), one of the hottest stocks between 2004 and the first half of 2006, noted Cramer. The whole run higher, skeptics were warning that the energy drink makers' momentum would fade, but with analysts still initiating coverage and touting the stock, it continued its run higher.

That was until May 10, 2006, recalled Cramer, when Hansen stock split five-for-one, but was also picked up by Goldman Sachs ( GS), the fourth analyst to begin coverage. After Goldman brought Hansen into the spotlight, Cramer said the stock immediately started to cool off, as it had hit that critical mass of analyst coverage.

Small momentum stocks are worth owning, said Cramer, but when investors see analysts jumping on the bandwagon, it's time to get out.

--Written by Scott Rutt in Washington, D.C.

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At the time of publication, Cramer's Action Alerts PLUS had no position in any of the stocks mentioned.

Jim Cramer, host of the CNBC television program "Mad Money," is a Markets Commentator for TheStreet.com, Inc., and CNBC, and a director and co-founder of TheStreet.com. All opinions expressed by Mr. Cramer on "Mad Money" are his own and do not reflect the opinions of TheStreet.com or its affiliates, or CNBC, NBC Universal or their parent company or affiliates. Mr. Cramer's opinions are based upon information he considers to be reliable, but neither TheStreet.com, nor CNBC, nor either of their affiliates and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such. Mr. Cramer's statements are based on his opinions at the time statements are made, and are subject to change without notice. No part of Mr. Cramer's compensation from CNBC or TheStreet.com is related to the specific opinions expressed by him on "Mad Money."

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