CAN SLIM: William O'Neal's Proven Strategy for Stock Market Success

Introduction to William O'Neal's "How to Make Money in Stocks"

William O'Neal's book "How to Make Money in Stocks" has become a cornerstone of investment literature since its initial publication in 2009. Despite being released in the aftermath of the financial crisis, the book has sold an impressive 2 million copies. O'Neal and his research team conducted an extensive study of the best-performing stocks over the past 125 years, presenting their findings in this comprehensive guide.

Unlike many traditional investment approaches, O'Neal advocates for market timing, active trading, and the interpretation of stock charts as key components of a successful investing strategy. This article will delve into the core principles of O'Neal's methodology, known as CAN SLIM, and provide insights into how investors can apply these concepts to their own portfolios.

Understanding the CAN SLIM System

CAN SLIM is an acronym developed by O'Neal to represent the seven key characteristics that the most successful stocks typically exhibit before making significant gains. Let's break down each component of this system:

C - Current Quarterly Earnings and Sales

This is perhaps the most critical factor in the CAN SLIM system. When evaluating potential investments, look for companies that show substantial increases in their current quarterly earnings per share compared to the same quarter in the previous year. O'Neal's research indicates that three out of four winning stocks demonstrated an average increase of 70% in this metric.

Key points to remember:

• Aim for at least a 20% increase in quarterly earnings as a minimum threshold.
• Accelerating growth is an even stronger positive indicator.
• Earnings growth should be accompanied by similar increases in sales.

A - Annual Earnings Increases

To ensure that the latest quarter's performance isn't an anomaly, examine the company's annual earnings growth per share over the past three years. Look for an average annual growth rate of at least 25% during this period.

N - New Products, Management, or Conditions

Innovation and change are often catalysts for significant stock price appreciation. This can manifest in various forms:

• Introduction of innovative products that outperform competitors or create new markets
• New management bringing fresh perspectives and organizational changes
• Shifts in industry conditions, such as supply shortages, geopolitical events, or technological advancements

O'Neal's research found that 95% of the market's top-performing stocks over the last century fell into one of these categories.

S - Supply and Demand

The fundamental economic principle of supply and demand applies equally to the stock market. When evaluating potential investments, consider the following:

• Companies that reduce the supply of their own stock through share buyback programs
• Management teams that demonstrate confidence by owning significant stakes in the company

L - Leader or Laggard

Focus on industry leaders rather than laggards. Aim to invest in the top one or two companies within strong industry groups. These leaders typically demonstrate superior quarterly and annual earnings growth compared to their competitors.

I - Institutional Sponsorship

Institutional investors, such as mutual funds and pension funds, can significantly impact a stock's demand and price movement. Look for companies that exhibit the following characteristics:

• Presence of institutional owners
• Some institutional owners are among the top performers in the asset management industry
• An increasing number of institutions owning the stock over the past year

When a fund establishes a new position in a stock, they often add to that position over time, potentially driving up the stock price.

M - Market Direction

Understanding the overall market direction is crucial, as it can impact even the strongest individual stocks. O'Neal emphasizes the importance of this factor so much that it warrants further exploration in the next section.

Determining Market Direction

Accurately assessing whether the market is in a bullish (uptrending) or bearish (downtrending) phase is essential for successful investing. O'Neal recommends being fully invested during bull markets, potentially even using leverage, while reducing exposure and raising cash during bear markets.

Here are some key indicators to help determine market direction:

1. Market Averages: Monitor major market indices relevant to your investments, such as:

   • S&P Global 1200
   • Nasdaq Composite
   • OMX Stockholm PI (for Swedish stocks)

2. Opening and Closing Patterns:

   • In bear markets, stocks often open strong but close weak
   • Bull markets typically show the opposite pattern

3. Distribution Days: A bull market may be ending when there are four or five days of "distribution" over a four to five-week span. A distribution day occurs when trading volume increases, but the index shows stalling or negative price development.

4. Follow-Through Days: A bear market may be ending when an index attempts a rally for three to six days and has a "follow-through" on the fourth to seventh day. A follow-through day is characterized by a distinctive price increase (preferably over 2%) combined with increased trading volume.

5. Contrarian Indicators: Ironically, the market tends to shift from bear to bull when most media outlets are portraying a bleak economic outlook.

6. Personal Performance: Evaluate your recent stock purchases. If you're profiting from most of them, it's likely a bull market. If you're consistently losing money, it may indicate a bear market.

The more indices that display these indicators, the stronger the signal for a potential market direction change.

Identifying Strong Base Patterns

Just as professionals in various fields rely on charts and data to make informed decisions, investors can use stock price and volume patterns to evaluate potential investments. O'Neal's research identified several base patterns that often precede significant price increases, with the "cup with handle" pattern being particularly noteworthy.

The Cup with Handle Pattern

This pattern resembles a cup with a handle when viewed from the side. Here are the key characteristics to look for:

1. Cup Width: The base typically lasts between 7 and 65 weeks.
2. Cup Depth: The decline in stock price before bouncing back is usually 12-30%, but can be higher if partly caused by a general market decline.
3. Cup Shape: A U-shaped cup is preferable to a V-shape, as it indicates a longer period of consolidation that forces out weak investors.
4. Handle Formation: The handle should form in the upper half of the cup and have a downward price drift ("shakeout").
5. Handle Characteristics:
   • Should not fall below the stock's 10-week moving average
   • Typically lasts for more than two weeks
6. Pivot Point: This is the optimal buying point, occurring when the handle's downtrend is broken on substantial increases in daily trading volume (look for at least 40-50% increase, but 200-500% or more is not uncommon for potential market leaders).
7. Price Tightness: Look for at least a few weeks of small price variations from the weekly highs and lows.
8. Volume Patterns: During the lows of the base (bottom of the cup and handle), decreasing volume is a sign of strength, indicating exhausted selling pressure.
9. Prior Price Increase: Before this pattern emerges, the stock should have shown a price increase of at least 30% with increasing trading volumes.

While the cup with handle is a powerful pattern, other useful base formations include the "cup without handle," "double bottom," and "flat base."

When to Sell: Protecting Your Profits

Knowing when to sell is just as important as knowing when to buy. O'Neal emphasizes the importance of having a strong defense to protect your gains and minimize losses. Here are two critical selling scenarios:

The 7-8% Rule: Cutting Losses Short

The most important rule for protecting your investment capital is to always sell when a stock drops 7-8% below your purchase price. This rule applies without exception and should be executed promptly. Here's why:

• A 20% loss requires a 25% gain to break even
• A 33% loss requires a 50% gain
• A 50% loss requires a 100% gain (doubling your money)

The longer you wait to cut your losses, the more difficult it becomes to recover. By adhering to the 7-8% rule, you limit your downside risk and preserve capital for future opportunities.

Nine Situations to Consider Selling for Profit

When your investments are performing well, it's important to have a plan for realizing gains. O'Neal outlines nine situations where selling might be appropriate:

1. Signs of Distribution: After a long advance, heavy daily volume without further gains signals potential selling pressure.

2. Stock Split: If a stock is up 25% or more within two weeks of a split, it may indicate excessive gains.

3. Upper Channel Line Break: A stock surging through its upper channel line after a considerable run-up often signals a selling opportunity.

4. New Highs on Poor Volume: Continued price increases with decreasing volume may indicate weakening demand.

5. Poor Relative Strength: If a stock isn't advancing in line with its index, it may be losing momentum.

6. Lone Ranger: A stock that's the only one advancing within its industry group may signal broader sector challenges.

7. Closing at Daily Lows: Repeated closes at or near the day's low price range is a bearish signal.

8. Earnings Slowdown: Two or more consecutive quarters of slowing earnings growth may indicate fundamental issues.

9. Significant Retreat from Peak: Consider selling if a stock falls 12-15% or more from its recent high.

Developing a systematic approach to selling, incorporating these guidelines, can help protect your profits and minimize the risk of giving back substantial gains.

Conclusion: Implementing the CAN SLIM Strategy

William O'Neal's CAN SLIM system offers a comprehensive approach to stock selection and market timing that has proven effective over many decades. By focusing on companies with strong fundamentals, innovative products or services, and institutional support, investors can identify potential market leaders before they make their biggest moves.

Key takeaways for implementing the CAN SLIM strategy include:

1. Rigorous Stock Selection: Use the CAN SLIM criteria to identify high-potential stocks with strong fundamentals and market leadership.

2. Market Timing: Develop skills to assess overall market direction, allowing you to adjust your investment strategy accordingly.

3. Technical Analysis: Learn to recognize strong base patterns, such as the cup with handle, to time your entries effectively.

4. Disciplined Selling: Implement a strict loss-cutting strategy and develop a systematic approach to realizing gains.

5. Continuous Learning: Dedicate time outside of regular business hours to study the market, analyze charts, and refine your investment strategy.

By combining these elements and consistently applying the principles outlined in "How to Make Money in Stocks," investors can work towards achieving superior returns and long-term success in the stock market.

Remember, successful investing requires ongoing education, discipline, and adaptability. As O'Neal emphasizes, it's the extra effort and study time you invest beyond the typical workweek that can make the difference between average results and truly life-changing investment success.

Implementing the CAN SLIM strategy may require adjustments to your current investment approach, but the potential rewards make it a worthy consideration for serious investors looking to outperform the market consistently.

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