Knowledge you need to know to be the best investor you can possibly be. Were taking timeout to impart some of that knowledge in a special show about the way stocks work and how they interrelate with the companies they stand for and represent, two different things. On mad money, we analyze companies, trying to see what makes them tick, what goals theyre supposed to meet, what expectations they are supposed to beat, the metrics. We dont trade those companies. We invest in their stocks and never forget the company and stock are not the same thing. I know. That might sound really obvious, the kind of thing should go without saying, but people constantly make the mistake of equating a company with its stock. And its the kind of mistake that can absolutely wreck your portfolio. Especially in volatile markets where many stocks trade off the big picture, socalled macro data about the broader global economy, the fiscal cliff, budget compromise, something in europe. Thats whats known as the macro. Rather than whats known as the micro, meaning information about the actual companies behind the stocks. Fact is, its all too easy to assume that a company and its stock are synonymous. A stock gets crushed, okay . And we assume there must be something wrong with the Underlying Company. Why else would the stock have been pounded . When a stock surges, we presume the company must be doing something right. But thats simply not how the markets work. Often shares of a Company Stock will have big moves up or down for reasons that have absolutely nothing to do with the underlying business. It happens all the time and it doesnt mean the market is crazy or irrational. What is irrational is believing there will always be a straight line, a lockstep, between the performance of a company and the performance of its stock. Why is that wrong . Shouldnt stocks trade based on the changes and the prospects of the Underlying Company . Isnt that the way the market should work when it isnt broken . Dont we spend lots of time on the show analyzing companies, look at them in a free and fair way, showing them to figure out what makes some businesses better than others and teaching you to identify situations where companies are improving. At least better than people think, right . Better than expected bt. Im always telling you the most important determine every of a higher stock price is increases from earnings estimates. Nothing correlates more with rising share price than estimate increase. Dividend boosts of decent magnitude. Why not enough to steady companies and buy the stocks that look like they have the ability to grow earnings faster than expected or grow the dividend . We cant buy companies, unless youve got hundreds of millions of dollars to throw around, its simply not an option. Instead, we buy shares of stock in those companies, shares that trade on an open market. We have lots of buyers and lots of sellers who might have very different motivations from you, when you find a highquality company with seemingly excellent prospects, you cant assume shares will go higher since you need to take the way the stock trades into account. Stock has its own method of trading. Like a dna for stock. Dont get me wrong. Over the long haul, the best way to pick stocks is by identifying winning companies, ones that are growing faster than anyone else expects and improving dramatically in actual performance. Especially on daytoday basis. They can trade wildly with little relation to whats happening with the company. Those movements can be so confounding that you end up selling low, or buying high. Or you give up entirely, and you know i think you need to stay in the game if you are going to augment that paycheck. Save money for retirement, vacation, tuition, necessities of life, all the things you want to have the money for. If you assume every move in the stock market makes sense, you will end up passing up some incredible opportunities. All aboard to buy merchandise thats been marked down for irrational reasons, meaning no reasons whatsoever, and you will miss moments when you should sell stocks that are run up too much courtesy of market mechanics rather than anything that relates to the Company Underneath the stock. In recent years, weve witnessed the rise of a ton of factors, and at least in the near term, over the longterm, they do tend to converge. That may be longer than you can wait. But over days, even weeks, months, you have all sorts of things this can make the stock of an improving company fall or the stock of a deteriorating company rise, many use Exchange Traded funds to get exposure to entire sectors, some allow them to buy or sell, giving them double or triple of the buying or selling back for the original buck. Regard this as needless proliferation of etf and we can trade in lockstep with each other. And the good in complete tandem with the bad is ultimately, the facts show out. A determinant. If the stocks a house, the sector is the neighborhood. And nobody wants a good house in a lousy neighborhood. But the influence of etfs becomes noxious, pernicious even it makes the sector more important than it should be, important than it should be, you have High Frequency traders who can actually really i have seen them hijack an entire market, causing massive across the board moves that make no sense in the fundamentals of the individual companies, especially moments of extreme volatility, new waves distort the stock picking beach. I hate it, and when times get tough for companies, they can get tougher for stocks. I spend a lot of time talking about foreselling, the idea that stocks can get slammed because Financial Institutions like hedge funds that own them are in trouble. Theyve borrowed too much money and need to raise cash in order to send some back to investors. This happens every time hedge funds make the same bet. Money managers who bet heavily in europe and lost when the eurozone indebted eurozone crisis, they didnt just have to sell european assets. They had to sell unrelated stocks too. Especially if investors were clamoring to get money back, and this is exactly what happened when we crashed in 2008 and 2009. Most stocks went down to absurdly cheap levels and it happened again with mf global. They ran out of capital and then the reverse happened in 2012. Those who bet against european stocks, all stocks had their heads handed to them, when they put the foot down on their necks and backstopped the Financial Institutions. It didnt matter, look, if a bank was solvent, insolvent, they flew up together. Most hedge funds have to make bets for or against stocks when shorts pile into a stock and get unexpected good news from a company, you get a short squeeze that propels the stocks to absurd heights, since short sellers have to buy to close out positions. Remember, the market is a market, which means its dominated by supply and demand. Not enough supply of a given stock or kind of stock to set that, you will see stocks rise beyond what it is expected to be based on fundamentals and too much supply relative to demand, then shares get hammered beyond what you think they might go to. We saw this with super hot areas like chinese internet ipos. Returns were staggering, but gains became smaller and smaller as we got more and more chinese dotcoms flooding the market with supply. Same thing that happened with the end of our own dotcom boom before we saw so much Insider Selling, we saw shares upon shares, it could happen again, deluge of social media in 2011, 2012, a repeat of what happened in 2001, 2002. In the end, no chinese deal is worth participating in. Demand was well oversaturated. This is one of the reasons chinese ipos reached lowest levels in 2012 in a decade. An 83 decline from 2011, 95 decline from 2010. And the last buyers out of the chute, they were crushed by ways of insiders bailing, seemingly at any price imaginable, just like what happened in this country in 2001, 2002. Super hot stocks became super cold ones. The public at first fascinated and then turn turned on them with a vengeance even as fundamentals were never really good to begin with. Bottom line, recognize whats happening with stocks doesnt always necessarily reflect whats going on with the underlying business and use that to your own advantage. A company in terrific shape sees stocks smashed for reasons unrelated to fundamentals that could be an amazing buying opportunity. Sometimes it can take a long time for the action in a stock to sync up with the performance of the company it represents, a tiny piece of. That way you wont be frustrated with what you thought should happen, after you heard fabulous news and instead, wait until the market gets smart and rewards your stock with the moves that it deserves. Larry in massachusetts. Larry. Caller greetings, rabbi cramer, from boston, formerly pennsylvania, formerly north bergen, new jersey. Whats up . Caller thank you for building the temple for Financial Wisdom and doing what mom felt was your highest and best calling, and you are gracious to all of us. Im an enthusiastic subscriber to action alerts. You talk about buying in wide scale, could you go into detail about buying down a good stock with bad news, particularly what percentage drop in the stock price, versus catching a falling knife . This is a tough question. Whether there is somewhat real money and somewhat in stay mad. What you got to do, look at the situation and say, look, i want to build a position thats 10 of my portfolio, what if i started buying 20 stock . Bought some at 20, some at 15, some at 12, would i be larger than 10 of my portfolio . If thats the case, buy down in a pyramid. Thats what i want. A pyramid buy. Joel in new york. Caller how are you, dr. Cramer . Real good, doctor, rabbi, whole thing covered. Whats going on . Caller joel from queensberg, new york. A big booyah to my wife gail, who handles all my trading. Gail rocks. Caller whats meant by restricted stock and how does it affect dividends on common and preferred . It means you literally have to get it to be free to trade. There are ways you have to do it, it has to do with restrictions that the government puts on it. You dont have to worry about restricted stock. It doesnt factor into the fundamentals of the company, which we really care about. Dont miss a second of mad money. Follow jimcramer on twitter. Have a question . Tweet cramer, madtweets. Send jim an email to madmoney cnbc. Com or call 1800743cnbc. A febreze experiment. To prove febreze can keep this car fresh, we loaded it with fast food, sweaty hockey gear, and a smelly dog cage. And parked it at a mall. In texas. For two days. Then put a febreze car vent clip on the dash and let in real people. It smells good. Like laundry fresh out of like the dryer. Yeah. A man fresh out of the shower. Nailed it. Oh yeah. Proof. Febreze car vent clips keep your car fresh. Another way febreze helps you breathe happy. To get your family together for breakfast. [ clears throat ] [ female announcer ] in fact, they might work too well. [ children laugh ] [ female announcer ] eggo waffles. Simply delicious. It sparks a movement. Because people cant keep it to themselves. Look no ugly spots awesome incredible shine. Im switching for good. Love, love, love finish over a Million People have switched to finish. Visit us on facebook. I havent thought about aspirin for years. Aspirin wouldnt really help my headache, i dont think. Aspirin is just old school. People have doubts about taking aspirin for pain. But they havent experienced extra strength bayer advanced aspirin. In fact, in a recent survey, 95 of people who tried it agreed that it relieved their headache fast. Whats different . It has microparticles. Enters the bloodstream fast and rushes relief to the site of pain. Visit fastreliefchallenge. Com today for a special trial offer. Welcome back to tonights special edition of mad money, where i try to explain what moves stocks up, what really moves them and how they diverge from the companies they purport to represent. I talked about the need for investors to get familiar with how stocks trade. You need to know about the traders that drive stocks in Different Directions and watch shortterm moves in stock prices, take advantage of them rather than pretending like so many pundits do, that shortterm gyrations are beneath their notice and will somehow pollute gains. May we never be so selfimportant or arrogant as to think that entry and exit points dont matter. They control the ability to outperform the market and make a lot of money. We care more about prices at the supermarket sometimes than we do about the prices of stocks we buy. Thats just plain wrong. So how do we square the idea that when you buy a stock, its price can become unglued from the underlying fundamentals of the company . With my insistence you do your homework . Whats the point . Keep track of the fundamentals, read quarterly Conference Calls and myriad research pieces, now readily available on the web to keep current. Why bother . If stock prices are going to bounce around at the mercy of macro factors that companies cant control, sound familiar . Or if they are held hostage by hedge funds that trade them, why the relentless focus on learning as much as you can about the Underlying Company . Am i nuts . Why . Especially given that homework is by far the onerous and for most folks, the least interesting part of the process . The fundamentals matter a whole lot and they are knowable. The reason we focus on fundamentals, just about anyone can do it, and the information is readily available, public, and on the web and in short, when you may think the homework is tedious and boring, its also easy to predict so much of whats out there that is simply unknowable. Investors look for an edge, a leg up that provides them with an advantage. That will never change. Not all advantages are of the same scale, but by following my standard homework regimen, you should have an edge over most of the people who trade the stocks you follow. How on earth is that possible . Yours involve looking at publicly available information. According to some economists and arm chair investors and a lot of gray beards who are critical of the show, it should be baked in to the stock. Meaning the share price should reflect everything you know from the research already, but you know something . Come on, you and i know thats not how the market really works. Lots of people are lazy, Money Managers are technicians, look at the charts, dismiss the fundamentals and dont get down and dirty to the nitty gritty of the Quarterly Earnings conference. If you keep up with the information you will know more about the stock than many professionals do, and if thats not an edge, i dont know what is. Homework is about taking control of your own financial destiny, eliminating as much emotion as possible. Thats what were trying to do. Get that out of equation. Thats why i focus on the homework. I know it will get results. Not just any results, the factual, objective kind, not the fiscal cliff that might be irrelevant to your stocks or Federal Reserve minutes. They might not mean anything to your position. The homework wont always give you information, enough information to tell you which direction a stock will head, and wont protect you from the whims, yes, call them children in washington that play with the economy willynilly and debt issues affecting any number of rogue nations in europe. But it isnt an all or nothing proposition. I dont think familiarizing yourself with a company should ever be dismissed as less than useful. And i said at the top of the show, stocks tend to drift back in line with where they deserve to trade. In addition to knowing a lot of pertinent things about a business, you can assume your stock will end up with a certain price range, really. If you wait long enough it will happen. It happens a big percentage of the time and if you keep up with the homework, a good, clean way of deciding whether or not to cut your losses in a stock that isnt working, which is an incredibly valuable tool especially when you are trying to claw your way back because your stock went down because of a typical market selloff. You need to know whether you should perhaps be a buyer, if nothing is going wrong with the company. You know whether opportunity is knocking or your head is about to be knocked to the canvas. On the other hand, it will give you the conviction to stay in a good stock hammered by the market for the wrong reasons, you will always know why you are buying or selling something. Isnt that good . You wont be beholden to anyone but yourself. Thats why i teach every night. Now, the better you are at avoiding stocks with a risk reward thats good for bad or bad to good, the better position to take more calculated, intelligent risks, more aggressive with your investments, these skills are useful no matter what, but they are paramount when investing, needing to protect your capital and needing to risk. Thats what the fundamental research and investing is. Even though these skills are handy, they arent compelling and may not give you the total picture and the boredom factor. Think about what ive done out here. Ive spent years trying to make it more accessible and interesting, even intriguing if not entertaining. No sin, given that so many focus on scaring you out of your shoes, and i have shown a willingness to get investors engaged, keep them engaged, especially on this show. Ive filmed while wearing a hazmat suit to compare hasbro to mattel. Ive taken a nap on a cozy bed of cheerios, driven on set on my lawn mower to look at john deere. I cant even put a dollar amount on the gizmos that i have wrecked. I have invoked onehit wonders and rappers like biggie smalls. I have chipped a tooth not to tell you to touch the stock of crispy creme. I ate pepperoni dog food and threw up on the set all over my wing tips. Im not concerned that you will skip the homework because we have ways of making you motivated. Bottom line, its really important for you to know why you are doing the work. Whats the point . A way for you to build conviction in your stocks, get an edge. One thats totally legal, volatile or calm with markets. So many panic at the sight of the president coming to the podium. It might be a buying opportunity and not just a selling one like all of those panickers around you. Ed in california. Ed. Booyah, this is ed from northern california. Thank you for calling. Jim, in your last book, and on your show, you have mentioned on numerous occasions to buy deep in the money calls. Yes. If my memory serves me correctly, you recommend buying these calls about three to four months out. My question is this with the volatility due to the market with several Ongoing Events is it okay to buy these calls out