“How to Make Money in Stocks” by William J. O’Neil

make_money_in_stocks

William O’Neil is the famous founder of Investor’s Business Daily (ironically now printed only weekly) and seems to deserve his reputation as a pro stock picker.  He shares his secrets in this book (along with plenty of plugging for IBD products…).  He outright refutes the concept of a “random walk” (throwing darts directly at Malkiel?), claiming it is definitely possible to beat the market.

CAN SLIM is O’Neil’s stock picking system (it’s not a weight loss system as the name may imply):

  • C – Current earnings per share >20% higher than same quarter one year ago. Also check that sales are increasing over the last three quarters.
  • A – Annual earnings per share growth of 25 – 50% over past 3 years. Also look for high ROE.
  • N – positive News. Don’t be afraid to buy a stock making new highs. Don’t worry about P/E ratio at all. Focus on newer companies (<10 years since IPO).
  • S – prefer companies with smaller number of outstanding Shares – easier to budge price.
  • L – (Leaders vs. Laggards) DON’T buy stock which has retreated to the point it looks like a bargain – too much risk it will keep falling. Buy when going up and hope it keeps going higher. Look for breakout after 7-8 weeks of stable base. Look for high, increasing relative strength. Average up if you must (when your pick is up a few %) but never average down.
  • I – look for increasing Institutional sponsorship, especially from high performing mutual funds.
  • M – sign of Market top: “distribution day” (distribution as in “selling”) – major indices flat or down on increased volume from previous day, occurring on 4-5 days in 4-5 week period.  When a bear market is detected, get into cash fast.  Then wait for the signs of a bull market before jumping back in: look for an up day, followed within 4-7 days by a “follow-through” day of very large gains (~2%) on heavier volume than the preceding day.

After all that…O’Neil admits that only 10 – 20% of his picks have ever turned out to be real winners. So, the savvy investor must be aggressive about limiting losses. Always cut and run if stock goes down 7-8%.  Think of it like insurance.  A variant that yields same results but is maybe easier to swallow: sell half at -5%, other half at -10%.  Given that expected gains on remaining winners are 20-25% you’ll still come out ahead if you can pick winners only 1/3 of the time.  If you must invest during a bear market (not recommended), lower your acceptable loss to 3% and profit taking to 15%.

Other sell signs (some confusing and contradictory – maybe why the aforementioned 20% rule exists):

  • largest daily gain or loss occurring after many days of solid gains
  • heavy volume with no price change or loss
  • rapid price run-up for 7-8 days out of 10
  • 4-5 down days for every 2-3 up days (whereas it had been the reverse)
  • new high on lower volume
  • close at day’s low for several days
  • 8% decline from peak
  • major publicity with good news
  • overabundance of optimism
  • deceleration in quarterly earnings increases for two quarters in a row

Don’t buy stocks <$15. O’Neil recommends holding no more than 5 stocks, since timing is important and monitoring multiple holdings may cause you to miss something important. Don’ be afraid to use margin once you are comfortable with the system and are seeing success.

Biggest mistakes: stubbornly holding on to losses for too long, buying on the way down, and not sticking to rules!

Research winning companies/industries to find opportunities in supplier companies – eg. Monogram, maker of chemical toilets for Boeing during airline boom.

There’s a lot of technical analysis charting discussed in the book, primarily focused on the perfect buy point.  I didn’t spend too much time squinting at the charts – seems like there are plenty of points on the charts which meet the cup-and-handle or stable base criteria but did NOT turn out to be a perfect buy point.  Anyway, cup-and-handle with large volume increase on the handle seems to be the recommended buy point.  Basically looking for a point where price and volume steadily drops for a time, then slowly picks back up until a large volume, large increase day.  (Only buy solid CAN SLIM companies – not just anything which meets the technical pattern!)

I plan to test out a few things from this book on Quantopian, particularly the market direction signals.  Even if you could just time the market and jump into and out of index funds at the appropriate time you would end up miles ahead.

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One response

  1. Analysis of CAN SLIM: http://seekingalpha.com/instablog/8701801-the-tenacious-trader/1747651-can-slim-a-snipers-approach-to-investing-in-stocks

    The strict requirements seem to limit gains, but serve to keep you out of the market during dangerous times.

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