William O'Neal published "How to make money in stocks" for the first time in 2009, right after the market meltdown
that was the financial crisis.
Even though the timing of the release could have been better "How to make money in stocks" has managed to sell 2 million copies.
O'Neal and his research team have investigated the best performing stocks in the last 125 years.
Their conclusions are presented in this book. Contrary to many of the advice
I've delivered on this channel before, O'Neal believes that market timing, trading and interpretation of stock charts can help significantly in your investing.
Takeaway number 1: Follow CAN SLIM
CAN SLIM is a system for selecting stocks created by O'Neal. Each letter in the acronym
stands for a key factor to look for when purchasing a stock. These are characteristics that the greatest winning stocks show in their early stages,
before they make huge profits for their owners. C - Current quarterly earnings and sales
This is the characteristic among winning stocks that stood out the most.
Your stocks should always show a major increase in current quarterly earnings per share
compared to the same quarter last year. Three out of four of the winning stocks had an average increase of 70%.
Use at least 20% as your threshold. If the growth is accelerating,
it's an even better sign. The earnings growth should also be accompanied by similar increases in sales.
A. Annual earnings increases. To make sure that the latest quarter isn't just a fluke, look also at the last three years of annual earnings growth per
share. They should be up on, average at least 25% per year.
N - New products, management or conditions. It takes something new to produce great advancements in a stock.
It could be an innovative product that either beats competitors, or creates new markets. A new CEO that brings new,
organizational behavior. Or changed
conditions in an industry such as supply shortages, war or new technology. The stocks that have been the superstars of the market in the last
century falls into one of these categories in 95% of the cases.
S - Supply and demand. The price in a free market is always decided by supply and demand.
Lingonberry jam, Dala horses, salt licorice, cheese slicers, polka pigs and
princess cakes, all follow this rule. And so do stocks.
Look for a company that reduces the supply of its own stock through re buying programs. Look also for a company where top management demand a
piece of the company's profit and show this by being share owners. L - Leader or laggard.
Buy leaders, not laggards. Aim to get the number one or number two company from a strong
industry group. Such a company has better quarterly an annual earnings growth than its competition.
Remember: The first man gets the oyster, the second gets the shell.
I - Institutional sponsorship
Do you remember what we said earlier about supply and demand?
The biggest source of demand comes from institutional investors. Look for companies where there are
institutional owners, where some of them are among the top performers of the asset management industry, and where the number of
institutions owning the stock has increased in the latest year. When a fund establishes a new position,
chances are that they will add to that position later, which will cause increases in price.
M - Market direction. You can be right about all the six factors that we just mentioned,
but if you're wrong about the market direction, you'll lose money in most of the cases anyways.
O'Neil puts so much emphasis on this part of CANSLIM, that it will be .....
Takeaway number 2: How you can decide the market direction.
You must have something in your toolkit that can decide whether the general market is a bullish (uptrending) one, or a bearish (downtrending) one. Why?
Because you want to be fully invested during bull markets,
perhaps even using some borrowing to increase your leverage, while you want to free cash and exit the market during bears.
The best indications you can get on up or down trends come from the major
general market averages and their price and volume changes.
The market averages are displayed in the most commonly used market indices, such as: The S&P Global 1200.
The Nasdaq Composite. The OMX Stockholm PI. Follow indices that are relevant for your specific stock. For instance,
if you hold a company that operates in America and is included in the Nasdaq Composite,
that index is of high importance to you. An index on a higher level of abstraction, such as the S&P global 1200,
is also or value. The OMX Stockholm PI on the other hand, is on less importance in this case.
Here, I will list a few of the indicators that O'Neil uses to evaluate whether we are in a bull or bear market. In bear markets,
stocks usually open strong, but close weak. In bull markets,
we see the opposite.
A bull market usually comes to an end when there's been four or five days of "distribution" over the span of four to five weeks.
A day of distribution means that the trading volume in the stock market index has been
increasing, but the index shows a stalling or negative price development.
Conversely, a bear market usually comes to an end when an index has been attempting a rally for three to six days and
has a "follow through" on the fourth to seventh day.
Attempting a rally is defined as either closing at a higher price than the day before, or recovering a downswing from the AM in the PM.
A follow-through is defined as a day where prices are up distinctively (plus two percent preferred) combined with increases in daily trading volumes.
The market tends to (ironically) shift from bear to bull when most newspapers are portraying a pitch-black future of the economy.
A shift in market direction can also be detected by evaluating your last four or five purchases you've made.
If you're up on all of them,
it's probably a bull market. If you haven't made a dime in any, it's probably a bear market.
In general, the more indices that these indicators can be spotted in, the stronger the signal value.
Takeaway number 3: Buy stocks from a strong base. In medicine, doctors consider charts of EKGs,
ultrasound waves, and the likes. Atmospheric scientists study models and charts to predict the weather.
Politicians (hopefully) use charts and other statistics as a basis for deciding about future laws and budgeting. In almost every field, there are tools available
to help evaluate conditions and interpret information correctly. The same holds true for investing and your primary source of information
here, are the price and volume patterns of a stock.
Sometimes these shapes are healthy and strong, and are said to form a "strong base". Other times,
they are weak and abnormal, forming a "weak base".
In O'Neil and his team's studies of the greatest stocks in the latest century, one base has been especially profitable: "The cup with handle".
The cup with handle looks like (surprise, surprise!) a cup with handle when viewed from the side.
The width of the cup,
which is how long the base lasts is typically 7-65 weeks. The height of the cup,
which is how deep the decline of the stock was before it bounced back, is typically 12-30%.
The height could be even higher if the decline was caused partly by a general market decline.
Contrary to how you want your shoulders to be shaped, this cup shouldn't be formed like a V.
It's better when it looks like a U. The reason is because when the lowest part of the cup last longer,
weak investors are forced out. A solid foundation of holders who are less willing to sell during the next uptrend is thereby established.
Alright, now on to the handle. The handle should form in the upper half of the cup as measured from the absolute top to the
absolute bottom of the cup and have a downward price drift, a so called "shakeout". The handle itself
shouldn't go below the stocks 10-week moving average. It typically lasts for more than two weeks.
After the handle comes the "pivot point", which is our buying point.
Jesse Livermore, who's a legendary investor from the first half of the 20th century, founded this expression.
The pivot point comes when the downtrend of the handle is broken on substantial increases in daily trading volume.
Look for increases of at least 40 to 50%,
but it's not uncommon that new market leaders show 200, 500 or even a 1000% increases.
This is a definite sign that professional institutions have started to notice the stock.
Typically, you also want a price pattern to have at least a few weeks of "tightness",
which is defined as small price variations from the highs and lows of the week. Also, during the lows of the base,
which is the bottom of the cup and handle respectively, it's a sign of strength if the volume dries up.
This means that the selling is exhausted. Before this pattern shows up,
you always want a price increase in the stock of at least 30% Also, trading volumes should be up. "Not my cup of tea!"
That's fine.
There are other price patterns that are useful for buying - such as the "cup without handle" the "double bottom" and the "flat base".
Takeaway number 4: 1 time you should always sell your stock.
The best offense is a strong defense, right? If you ever attended the PE classes in school, or watched a game of football,
you know this. In the stock market, this cliche holds true as well.
If you don't learn to protect yourself against large losses,
you absolutely can't win the game of investing!
The secret to winning big in the stock market is not to be right all the time,
but to lose the least amount of money possible when you're wrong.
But how do you know where you're wrong then? Easy! The price of the stock drops below the price you paid for it.
For each point your favorite holding drops below what you paid for it, both the risk that you're wrong, and the price you're going to pay for
being so, increases. Therefore, cut every loss short and a 7-8% decline. There are no exceptions to this.
Don't wait a few days to see what happens. Don't hope that the stock will rally back up. Don't wait for the market close
Remember: A 20% loss must be followed by 25% gain to break-even.
A 33% loss requires a
50% gain. And at minus 50%, you must do a double up. In other words, the longer you wait,
the more the math works against you.
Cutting your losses short is much better than waiting and hoping for them to return. Many of them don't.
Takeaway number 5: 9 times you should consider selling your stock.
All right.
Now you know what to do if your stock falls below your purchase price.
But if you restrict your buying to stock that
pass CAN SLIM and that comes from a strong base, such as the cup with handle in takeaway number three,
this should happen too often. In effect, the question changes from "when do I accept my losses?" to "when should I realize my gains?"
I will give you 9 situations in which you might consider doing this, but first, here's a story to reflect upon.
A little boy was walking down the road, when he encountered a man who was trying to catch turkeys. "I've set up a trap with a
box, a prop to hold the box up, and a trail of corn that will lure the turkeys in under the box"
the man explained. "Once there are enough turkeys under it. I will pull the prop and catch them!"
"I can't do it too early though, as pulling the prop will scare away any turkeys nearby, and I only have one shot."
"Ah, simple enough" the boy thought as he sat down to watch the man. At one point,
there were 12 turkeys under the box. After a while
one of them left, leaving 11. "Snap, I should have pulled when there were 12 of them!" the man complained.
"Let's wait a minute to see if it returns." While he waited for the 12th turkey to come back, another two walked away.
"Aww, I should be satisfied with 11!" Another three walked out. Still, the man didn't pull, the boy noticed. Having once had 12 turkeys,
he disliked going home with six. Ten minutes later, the box was empty, and the man returned home empty-handed.
Moral of the story: You must establish a plan for when to realize you games.
Don't wait for your stock to return to its former heights. Instead, be humble, for you might lose it all.
Now, here are the 9 situations:
1. Signs of distribution. After a long advance, heavy daily volume without further gains signals
distribution. A few of these days during a short period of time screams sell time.
2. Stock split. If the stock is up 25% or more within two weeks of a stock split,
it's usually an excessive gain. Time to pull the plug.
3. Upper channel line. A stock that surges through its upper channel line after a considerable run-up
can usually be sold. You can draw an upper channel line by connecting the last three high points of the last four to five
months on a stock chart.
4. New highs on poor volume. If the volume dries up, but the stock continues to soar, you might consider selling.
5. Poor relative strength. Is the stock not advancing like the index
it belongs to? This is a sign of weakness and one that usually means that it's time to terminate.
6. Lone ranger. A stock which is the only one still advancing within its industry group could mean two things:
1. It has eliminated all competition, or 2. The industry group as a whole is facing tougher times. Usually it's the letter that has happened.
7. Closing at, or close to, the day's price low.
Does the stock repeatedly close at the lowest price range of the day? In that case,
watch out! 8. Earnings slowdown. If the increase in earnings are slowing down for two consecutive quarters or more,
there's a fundamental reason to sell the stock. 9. Sell all the way back down again.
You should always sell your stock
if it goes too far from its peak.
Too far differs between each individual stock, but a rule of thumb is somewhere beyond 12-15%.
Note that it's common that one of the aforementioned selling points are reached before of this happens.
Now, let's summarize what this book has taught. Takeaway number 1 is that before buying a stock,
make sure that it passes the CAN SLIM test.
Advice number 2 is that every investor must have tools for deciding whether we are in a bull or bear market.
This is important because using leverage in a bull market, while raising cash in a bear market will increase your gains tremendously.
The third tip is that it's not enough for a stock to pass CAN SLIM, for you to invest in it. The best opportunities arise
from stocks that are also forming strong bases, such as the cup with handle.
Takeaway number 4 is that you must face reality when you're wrong and limit your losses. You do this by selling
everything that goes below 7 to 8% of your purchasing price. Lastly, takeaway number 5 is that there are multiple
situations where it's time to realize your stock gains.
Develop a system for this, and don't be afraid to steal a few of O'Neill's time-tested methods for it!
A final advice from the author:
It's always the study and learning time that you put in after 9-5, Monday through Friday, that ultimately makes the difference between winning
and reaching your goals, and missing out on truly great opportunities that really can change your whole life.
Cheers guys!