Disclaimer: This is not financial advice. Please consult a professional before taking any action.
William O’Neil’s Perspective
William O’Neil is a noted stockbroker, writer, and entrepreneur. He founded the stock brokerage firm William J. O’Neil & Co. Inc. in 1963. He is also the founder and chairman of Investor’s Business Daily, an influential investment publication. Born in 1933, O’Neil was one of the first investors to include computers in his investment research and decision-making process. At 30, he became the youngest person to sit on the New York Stock Exchange (NYSE).
How to Make Money in Stocks has sold over 2 million copies worldwide. O’Neil’s CAN SLIM Investing system makes it easy for investors to pick good stocks. He also shares tips to help budding investors to choose the best mutual funds and ETFs. The book aims to show you how to make intelligent investments, even if you haven’t owned stocks before. As a new investor, you’ll have many questions, such as where do I start? What should I look for in a stock? This guide has you covered.
StoryShot #1: Learn to Read Charts
Charts help track the daily price changes of stock based on supply and demand in the stock market. Learning to decode price movements on charts is key to making money in the stock market in the long run.
Don’t buy a stock solely based on its fundamental characteristics (cash flow, ROI, history of profit retention, etc.). Charts present a stock’s price and volume history to you to decide if the stock is strong and worth buying or weak.
Always carry out a technical analysis of a stock using its price chart before investing. An analysis helps determine when a stock is worth buying at a price point and when to sell. You should also learn to spot patterns on the price chart to predict price movements. Price patterns and technical indicators give you a great idea of strong entry and exit points.
StoryShot #2: How to Pick Quality Stocks Using the CAN SLIM Strategy
The CAN SLIM strategy, created by O’Neil, makes it easy for a new investor to start investing. Each letter of the CAN SLIM acronym represents an essential factor in buying stock. Each factor is based on research of the best-performing stocks of the past century.
One of the best indicators of a good stock is accelerated quarterly earnings. Excellent earnings have always boosted stock prices in the stock market. So, choose stocks with a significant percentage increase year-on-year.
To do this, check the Earnings Per Share (EPS) number. You can calculate EPS by dividing a company’s total after-tax profits by the number of common shares. The quarterly percentage change in EPS is a critical metric in your analysis. The higher the percentage increase, the better. Comparing EPS of the same quarters gives a more accurate reading and avoids seasonal fluctuations.
A: Annual Earnings Increases
To make sure the latest quarterly growth is not a fluke, check the company’s annual earnings growth rate over the previous years. An annual growth rate of at least 25% is a good starting point. Return on Equity (ROE) is another helpful metric that measures how well a company uses its money. You can calculate the ROE by dividing net income by shareholders’ equity. Focus on stocks with significant earnings growth in the last three years.
N: Newer Companies, New Products, New Management, New Highs Off Properly Formed Bases
Most winning stock in the past century has benefited from changed circumstances. These could be products and services or the introduction of revolutionary technologies. For example, Apple’s stock prices increased dramatically after releasing the new iPod. This significantly boosted the company’s stock price at the time.
Companies involved in innovation or launching new products will always see a boost in stock prices. Also, consider companies with new and credible management or improved industry conditions.
Once you’ve found a contender, buy their stocks in times of price consolidation and price breakouts for the best return. Price consolidation means the price of the stock has stopped moving up or down after it has broken through support (the lowest recorded stock price) or resistance (the highest recorded stock price) levels. Price breakouts happen when a stock’s price moves beyond those two limitations.
StoryShot #3: What You Should Look for in a Quality Stock
It’s important to understand the fundamental concepts of the stock market. These are essential factors encompassed in the second half of the CAN SLIM strategy.
S: Supply and Demand
The best way to measure a stock’s supply and demand is by watching its daily trading volume. The stock’s trading volume is an excellent indicator of its fundamental buying and selling pressure. Higher trading volumes are preferable as they show buying pressure from institutions.
Stocks with a smaller supply are more likely to be better performers due to their higher room for growth. Small-cap stocks are also more volatile due to lower liquidity, causing price fluctuations. Keep an eye out for companies that buy their own stock in the open market. This reduces the number of shares and tells you the company is confident moving forward.
L: Leader or Laggard
Leaders are the best-performing stocks in a given sector. Those that fall behind their competitors are the laggards. In any sector, buy the top two or three stocks, which will be industry leaders in their respective fields. This doesn’t necessarily mean the largest or most popular companies. Instead, the ones with the best fundamentals. Focus on stocks with the best annual earnings growth, the highest return on equity, and the widest profit margin.
Avoid sympathy plays and impulse stock purchases. For example, if news from a competitor affects a company’s stock prices, it’s a sympathy play and a sign of risk.
Sell the worst performers in your stock portfolio when the loss is small. Hold on to your good performers to see if they grow into your best-winning stocks. Holding your losers, hoping for a recovery, and selling your winners will always lead to more considerable losses. If you invest in laggard stocks and lose money, exit and cut your losses at 8% below your buying price.
I: Institutional Sponsorship
Institutional sponsorship refers to shares of any stock owned by institutional investors. This includes hedge funds, state institutions, mutual funds, and insurance companies. Institutional sponsorship is beneficial for two main reasons:
- It provides buying support when you want to sell your investments.
- It provides continuous liquidity, thereby maintaining a steady market.
Having said that, be wary of stocks “over-owned” by institutions. Excessive institutional sponsorship could translate into large-scale selling. You’ll usually see this in a bear market (when stock prices fall). Hence, only buy stocks with at least a few institutional sponsors with strong recent performance records. Selected stocks should have also added institutional owners in recent quarters.
M: Market Direction
You’re likely to lose money if you’re wrong about where the market is heading. Having said that, you don’t need to be psychic to survive in the market. Focus on what the market has done in the past by reading price charts and checking volume indicators. This will give you enough understanding of long-term trends to make a profit in the stock market.
StoryShot #4: When Should You Sell Your Stock?
Always, without exception, sell your stock the moment its value drops by 7% or 8% from the price you bought it at. Not selling your losses and hoping that the stock will recover is a recipe for disaster. In fact, you’re likely to end up with significant losses. Let’s say that you’re down 20% on a stock. You would need the stock to go back up 25% just to get back to the price you purchased it. Similarly, a 33% loss requires a 50% gain to break even. The longer you wait, the more the math works against you, and the harder it is to recover your money.
You don’t win big in the stock market by being right all the time but by losing the least amount of money when you’re wrong. Knowing when to cut your losses is an equally important factor, if not more so, than knowing when to invest in a stock. Hence, limit your losses to 7% or 8% of your cost.
Accept that you might make mistakes in stock selection and timing now and then. It is nearly impossible to correctly predict the stock market every time. Sometimes, even the most experienced investors follow the market direction and pick the wrong stocks. It is important that you take your losses quickly and your profits slowly, not the other way around.
StoryShot #5: When Should You Consider Selling Your Stock?
O’Neil recommends watching out for selling signs, even when stock prices are rising. This ensures you sell your stock and book your profit before it’s too late. Here are a few signs that let you know it could be time to sell:
Signs of Distribution
Heavy daily volume without a noticeable price increase is a sign of distribution. Sell your stock before general investors spot the sudden price movements.
First Drop from Peak
If you don’t sell during the stock price rally, sell on the way down from the peak and book your profits. Generally, the first breakdown is a good time to sell your holdings.
200-Day Moving Average
Stocks 70% to 100% above their 200-day moving average price line are also worth selling. Consider selling a stock if its 200-day moving average price line turns downward after a price rally.
Upper Channel Line
An upper channel line connects the previous three price highs of the stock that occurred in the last four to five months on the stock chart. A stock that rises over its upper channel line following a price upswing can also be sold.
It may be time to sell a stock when the percentage increase in quarterly earnings slows down for two consecutive quarters.
StoryShot #6: How To Invest in Mutual Funds
A mutual fund is a portfolio of stocks managed by a professional investment company. Investors buy shares in the mutual fund and make or lose money based on the net profits and losses of the stocks within the fund.
The best way to make a fortune in mutual funds is through the power of compounding. Compounding occurs when your earnings generate more earnings over time, boosting what you invest. The longer the time duration, the more pronounced compounding effects become. There is no right time to start investing in a mutual fund. Think long-term and focus on building capital that will compound over the years.
StoryShot #7: Avoid These Common Mutual Fund Investing Mistakes
Mutual funds are a great way to reap profits in the long run if you sit tight and let the magic of compounding take over. Avoid making the following mistakes, and you’re good to go:
- Being affected by market news and not thinking long-term.
- Worrying too much over a fund’s management fee and turnover rate.
- Not giving at least 10 to 15 years.
- Selling out of fear during bad markets.
- Losing patience and confidence in the power of compounding.
StoryShot #8: Avoid These General Investing Mistakes
Investors lose money in the stock market due to two main reasons: poor investing habits and not sticking to a proven system. Here are some costly mistakes most investors make that you must avoid:
Holding on to losses when they are very small and reasonable
Investing in stocks can be risky, with uncertain price movements. To survive in the stock market, you must cut every loss short, especially when a stock falls 7 or 8% below your buying price.
Not following your buy and sell rules
Make firm decisions and trust your historically proven rules and game plan. Not doing so pushes you towards making more mistakes as you progress.
Stop thinking about the number of shares you buy but the dollars you invest. Low-priced stocks can drop in price quicker than higher-priced ones, not to mention they carry greater risk. High-priced stocks also tend to have more institutional sponsorship, supporting price growth.
Buying on tips, rumors, news, and opinions from supposed market experts on TV.
Most rumors and tips you hear are simply not true. Avoid risking your money solely based on predictions and recommendations from someone else. Instead, study and understand the market and the factors affecting stock prices.
Not looking at stocks objectively.
Quit leaning on your personal opinions and blindly hoping to make a profit. Pay attention to the price and always follow the market, which is usually right.
Prematurely engaging in options or futures.
Options and futures are riskier since the trade contracts have limited periods. Do not enter into such contracts without any investing knowledge. Also, be careful while using borrowed money via margin and avoid excessive debt.
Final Summary and Review of How to Make Money in Stocks
Knowing how and where to invest to get the best returns can feel overwhelming as a beginner in the stock market. But by following the tips and tricks we’ve talked about from O’Neil’s bestselling book, you’re much more likely to make money with stocks in the long run. We’ve covered a lot of important points, so here’s a quick recap of what you’ve learned so far:
- The first step in learning how to pick big stock market gainers is studying winning stocks of the past. Learn the characteristics of the most successful stocks.
- Focus on stocks with exceptional earnings growth in the previous years.
- A company that buys back its own stock in the open market has confidence in its future growth. Use this as a good sign to invest.
- Focus on buying market leaders. To avoid huge losses, always get out of your losses by 8% below your buying price.
- Only buy stocks with a growing number of best-performing institutional investors.
- Identify the market direction by understanding the prices of daily market indexes. Avoid investing in a bear market and be prepared to enter while the market is bullish. This can determine whether you win big or lose.
- Always cut your losses quickly and do not average down in price in hopes of a price recovery. Don’t get emotionally attached to any stock that’s losing you money, and clearly define your selling rules and follow them.
- Never borrow more money than you can pay back. Excessive debt can severely hamper your finances.
We rate this book 4.1/5.
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