How to Make Money in
Stocks
About Author:
William J. O'Neil (born March 25, 1933) is an American
entrepreneur, stockbroker and writer, who founded the stock brokerage firm
William O'Neil & Co. Inc. in 1963 and the business newspaper Investor's
Business Daily in 1983. 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.
O'Neal believes that market timing, trading and interpretation of stock charts
can help significantly in your investing.
Summary of the Book:
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 increase.
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 behaviour 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 fall 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 companies 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.
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 (up trending) one, or a bearish (down
trending) 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
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 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 12-33%. 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. 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 cliché 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.
Takeaway number 5: 9 times you should
consider selling your stock:
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 is 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.
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! Happy Reading!!
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