|From:||IBD Meetup Irvine/NPB L.|
|Sent on:||Thursday, September 15, 2011 9:11 AM|
Below please find a recent two part series from an interview will William O’Neil.
We look forward to seeing everybody Wednesday Spetmeber 21st, 2011 at the IBD Meetup Irvine.
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Conversation with a maverick investor
Investment legend William O’Neil shares his market wisdom
By Kevin Marder
LOS ANGELES (MarketWatch) — The peanut-butter/chocolate moment in this trader’s career occurred in 1990. Midway through reading a book on how to make money in stocks, a giant light bulb switched on.
Suddenly it was as if the mysteries of the market — how to find big-winning stocks, why the market did what it did when it did, how to interpret the market’s message, when to become defensive and move to a cash position, among them — were no longer mysteries.
At that moment, the fog had cleared and all the elusive pieces in the puzzle came together.
This trader was so excited that he put the book down and began pacing the living room floor, pondering all the possibilities. It all made sense now. At last.
The book, “How To Make Money In Stocks” by William J. O’Neil, went on to become a runaway best-seller. The strategy, known by the acronym “CAN SLIM,“ was based upon an exhaustive research study conducted by O’Neil in the early-‘Sixties. In it, O’Neil looked at all of the biggest-winning stocks of the prior decade to see if they shared common characteristics. In fact, they did. O’Neil discovered there were seven key traits in each big winner, and he assigned each a letter, which comprised the trademark term CAN SLIM.
O’Neil, a young stockbroker at the time, proceeded to take this valuable information and began applying it to his account and those of his clients. Starting with $4,000 or $5,000 plus some borrowed money and use of margin, O’Neil had three big, back-to-back winners in his account beginning in late 1962. By the fall of 1963, the profits exceeded $200,000 and O’Neil proceeded to buy a seat on the New York Stock Exchange.
It is difficult to think of anyone having influenced more of this era’s most outstanding investors than O’Neil. Plenty of individual investors using CAN SLIM have clocked triple-digit annual gains in their accounts. Given the influence of the man on this trader and this column, it made sense to include the following interview, the first of two parts, and conducted via e-mail.
Bill, in your 50 years of experience in the market and working with investors, what is the biggest mistake the average investor makes?
Not having, and following, a strict rule to always sell and cut short your losses.
What is the most important personality trait that an investor should have to become successful in the market?
Willingness to work hard and correct your major weak points.
It has been said that a woman makes for a better investor than a man because a woman is less likely to let her ego get in the way of making investment decisions. Do you agree?
It all depends on if a person is motivated and determined to learn how to invest successfully and learn from their mistakes.
Some people are convinced the game is rigged. What would you say to them?
I’ve never met a successful pessimist.
Along these lines, in the past few decades, more investors appear to have thrown in the towel than any time in recent decades. Do you view this as a periodic cleaning-out process that needs to take place every so often or perhaps something more ominous?
No, it is the aftermath and severe unintended consequences of our government in 1995 and thereafter, mandating to banks and lenders whom they must make home loans to, or face penalties.
For decades, trading volume had been dominated by institutional investors such as mutual funds, pension funds, insurance companies, bank trust departments, etc. Their accumulation of a stock would clearly show up on a price/volume chart, and the same thing with a chart of an index such as the Industrials. Over the past three years, high-frequency trading has come to comprise a purported 60% of all trading volume. Doesn’t this fact make the volume that we see on stock charts and index charts less reliable as a means of detecting accumulation or distribution?
Not necessarily. The focus of supply and demand doesn’t change, and price and volume are still the best tool to carefully analyze supply and demand.
Other than a relative strength line and a moving average, do you ever use other technical indicators?
Very few. We use more fundamentals like accelerating earnings and sales growth, unique new products gaining market share, high ROE or pre-tax margins, good sponsorship, innovative entrepreneurial management, etc.
Why is it that you prefer looking at weekly price/volume charts than daily?
That’s how I started learning to recognize sound patterns under accumulation, and am still more accurate with weekly charts. They also give me a better overall picture. However, I also check both daily and long-term monthly charts.
I know in your first book you mention that only the price/volume behavior of the major averages and action of the leading stocks matters when it comes to general market analysis. We are not long-term investors, but to me the cumulative NYSE advance-decline line has value as a long-term indicator when it begins to diverge from the averages in a mature bull market. Do you have any use for the cumulative advance-decline line at all?
The A/D line is not a very precise timing tool and can sometimes be way too early. We’ve done very well in most cases by ignoring it.
Many investors using your strategy seem to view the follow-through day concept as a sort of magical elixir. Debates take place over how a follow through day should be interpreted. What would you say to them?
Keep studying, and go to a few workshops, like IBD’s Chart School Seminar.
You have been through so many market cycles. Over the years, have you seen any changes in the patterns that stocks make on their price charts?
The law of supply and demand and human nature remain the same. Chart patterns also remain the same. So the wise investor should learn to accurately read proper patterns.
In your first book, you mention that a typical growth stock will break out of a base and run up 20%-25% before pausing and perhaps building a second base. Does this still take place in a typical market leader, or is the move less than that after breakout?
It can vary depending on the type of market or stock you’re in.
You are a big proponent of owning stock in younger, entrepreneurial companies with innovative new products and services. Earlier this year, we began to see the IPO market perk up, at least until the recent market turbulence. What will it take to revive this engine of growth?
A new administration that believes in the free enterprise system, which led every market cycle for the past 150 years.
I have always felt that because each human being has a unique makeup of temperament, risk tolerance, experience, etc., an investor should take a strategy such as yours, or any other strategy for that matter, and make it their own by personalizing it. How do you feel about this?
That’s OK, but frequently trying to add to our system or tweak it doesn’t make it better. It’s hard enough to learn all the realistic rules and have the discipline to always follow them. So, concentrating on getting it all down and executing is in my view, the road to real investment success. IBD has thousands of investors that learned how to become winners, but it took them time to make it work. It’s not easy. Persistence helps.
Along these lines, what changes do you make in your own trading as compared with the guidelines of the CANSLIM methodology?
The Fed has its hands tied and fiscal stimulus is a bad word in Washington due to the large federal budget deficit. With this in mind, what concrete steps should the administration and Congress take to jump-start growth?
Democrats control the Presidency and the Senate. They control government policy which has not worked well. It will probably require new management to take place months after the November election to create strong tax incentives to start small businesses and help existing ones. Our studies show small business creates 80% of our job ... not the 60% our government incorrectly believes. Increasing taxes and spending more money is not a sound answer. It just creates more problems.
The bond market is certainly prepping for either a recession or a zero growth economy. Do you expect the U.S. to follow the way of Japan and enter a deflationary era?
I don’t predict.
Fitting in his location far from the canyons of Wall Street in Los Angeles, O’Neil does not concern himself with personal opinion or prediction. All that matters is fact and historical precedent. Of course, this is the diametric opposite of most other market seers.
His landmark research study of the early ‘60s was built on pure common sense and logic: Look at the biggest market winners of the past and see if a common thread runs among them. Then look for these seven characteristics in stocks of the future, and employ sound money management rules to protect precious capital when you either make a mistake or the general market flounders.
On Thursday I will continue my dialogue with O’Neil. He delves further into analyzing the 2011 stock market and some individual stocks. He also advises investors on what to look for to know when a new bull market may be upon us.
Marder on Markets
Sept. 15, 2011, 12:01 a.m. EDT
William O’Neil, part deux
The conversation continues with a market legend
By Kevin Marder
LOS ANGELES (MarketWatch) — The telephone rang on a sunny Sunday afternoon in California. On the other end was William O’Neil.
The living legend wanted to talk market.
When a man with one of the best track records extant wants to talk market, you do not disappointment him.
O’Neil, profiled in one of the classic Market Wizards books by Jack Schwager, founded Investor’s Business Daily (IBD) newspaper in 1984, for which he continues to serve as chairman.
Bill, the last time we spoke was in 1999. It is a very different environment today. Since then, some investors lost 50% of their portfolio during the ’00-’02 bear market, 50% of their portfolio during the ’07-’09 bear market, and perhaps 40% or more of the value of their home.
It’s nice to speak with you again, Kevin. I’d like to begin by saying that I did not create the investment system that we use. What we have done is gone back and looked at past market cycles, and we have now looked at 27 of them. We have built models based not on my opinion of the way the market is supposed to work, but based on how the market actually has worked during past bull and bear markets.
We found that bull markets are created by entrepreneurial companies with new products that do something either faster or cheaper or better. You can look at the ‘Nineties bull market, which was led by technology companies like Cisco, Dell, and Microsoft. In the most recent decade, it was innovative companies like Apple and Google
We have studied the way each bull market has topped and the way each bear market has bottomed going back 120 years. In our research, we have learned that indicators don’t work.
You believe that studying price and volume provides the most effective way to analyzing the general market.
That’s right. We do something different in Investor’s Business Daily. On one page we stack price/volume charts of the major averages, one on top of the other. We also include a chart of an index of growth-stock mutual funds. We look for divergences between the various averages.
We have found that the most effective way to analyze the general market is to simply watch how the averages behave. What is the market doing right now on a day-by-day basis? This means setting your personal opinion aside.
January is the most common month of the year for a bull market to top. And April is the second-most common month. This year the market started going through a distribution process in January that extended through April. We are in year three of a bull market. In past bull markets, the averages might rise 2% or 3% or 4% in such a period. However this is not a normal economic recovery. A normal recovery might last 3 ¾ to 4 years. The stock market goes through super-cycles that last 15 to 18 years or so. The ‘80s and ‘90s constituted one super-cycle. We are now in a different one, where the market moves up for two years and then back down for a couple of years.
You are a believer in watching for distribution days in the averages, indicating professional selling, to determine whether a market is topping. Is there a particular number of distribution days you use to tell you whether the market is beginning to get into trouble?
The number of distribution days that signals a probable top has changed over the years. This is due to the markets being so much larger than before. Institutions are managing a lot more money these days.
It used to be that three, four, or five distribution days would occur before a top was signaled. Nowadays, it can be up to six distribution days. What most investors don’t realize is that a market will undergo distribution as it is advancing.
Following an advance in the averages, I would ignore the first two days of distribution, but I would begin to get concerned on the third distribution day. On the fourth distribution day I would begin to sell some of my positions. On the fifth day, I would sell more, and on the sixth day I would sell more. The distribution day concept does not say how far down the market will go or how long the decline will last. It could be two days, two months, or two years. It is supply and demand that determines prices and how far a decline might go.
We have seven or eight internal portfolio managers. When the market topped on March 10, 2000, I think all of them were out of the market and in cash by March 14. And I never said a word to any of them.
And on the flip side, when a market is in a pronounced decline, you will look for a follow-through day to tell you when you can begin to buy stock again. (A follow-through day occurs when one or more of the major averages is up materially on volume greater than that of the prior day.)
Yes, I like to wait for a follow-through day. This normally occurs on the fourth to seventh day of rally from a low in the averages, although it can sometimes be on the 10th or 15th day. The follow-through day tells you that the trend is up. You don’t know how far up. Two out of every three of them may work.
And then once you see a follow-through day, you must study supply and demand in the market averages to know if the rally is failing. A rally failure does not necessarily mean an average has fallen to a new low after the follow-through day. It can also be related to how much distribution has occurred since the follow-through day.
Others can predict, but opinions can often be wrong. We don’t use any personal opinion. In our approach, we are bending with the market like a tree bends in the wind.
In terms of broad sectors or narrow groups, do you see much leadership currently?
The gold miners and a few retailers are acting well. But our work does not spend as much time with groups. We are more interested in buying the best company in a leading group. A company with good earnings and revenue growth, expanding profit margins, good return on equity, and that is a leader in its field.
Of course, I have to ask you which names you like in here.
We usually buy the most aggressive growth stocks in the market. But this is a time to be defensive. Autozone is a stock that has had consistent earnings growth and is in the business of selling auto parts to consumers. In a soft economy or recession, some individuals will postpone buying a new car, which should benefit a company like Autozone.
Another defensive stock is Colgate Palmolive , which has had consistent earnings growth, high return on equity, and is positioned to benefit from its stable line of businesses if the economy goes into recession.
Investors can learn more about our strategy by attending an IBD Meetup Group in their area.
We are seeing a number of speculative glamours act well, including Pricesmart Amazon.com , and Green Mountain Coffee Roasters act well. Do you see enough of this type of leadership to support a new bull market?, Ulta Salon and Athenahealth , all of which recently broke out of bases on volume; Cerner , which also broke out today; Dollar Tree , Acacia Research , Alexion Pharmaceuticals and Hansen Natural . We are also beginning to see some of the liquid glamours like Apple ,
Yes, there is enough leadership. These are the companies with stronger fundamentals, earnings, sales, ROE, product, etc. There are probably 20 stocks overall that have been big leaders. Some have been so for a long time. At some point, the fact that these stocks have run up so much since 2009 will be a problem. We’re still in a news-of-the-day market, which makes it difficult for everyone.
Overall, what is your outlook over the next few years?
We will eventually have another super-cycle of growth. But it will take a change of management. Bringing in new managers to replace the current ones should enable things to improve. And this process of improvement may begin after the 2012 election.
During this last bear market, the S&P 500 went down 58%. In a normal cycle, it should have gone down 20% or 25%. The housing sector has greatly contributed to this. I believe that Ben Bernanke said one new home is being built now versus the three that are usually built during a recovery.
Some people don’t realize this, but in 1995, it was mandated in Washington that a significant amount of new mortgages would go to people who would not normally qualify for one. It is right to try to help those who are less fortunate and might need some assistance in purchasing a home. But at the same time, the government just does not have the experience that banks and the private sector have when it comes to lending. This mandate was a major reason for the excesses seen in the housing market.
For someone who has probably influenced more highly successful investors than anyone else alive, Bill O’Neil remains strikingly humble. He has no interest in taking credit for creating the CAN SLIM investment system, a strategy used by countless thousands of devotees in virtually every country on the planet.
To O’Neil, the real star is the market.
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