Tuesday, November 30, 2010

The CAN SLIM System for Finding Growth Stocks

William J. O’Neil is the Founder of Investor’s Business Daily and the creator of the C.A.N.S.L.I.M. system for selecting growth stocks that move 100s – 1000s % in a Bull Market. He has studied the characteristics of stocks that were big winners since 1953 and came up with his now very popular CAN SLIM system. These growth stocks have two key components in their selection; fundamental indicated in the CAN SLIM approach outlined below, and Technicals in the cup-and-handle as well as the 7 week base then breakout approach to time entry into these stocks. There are other key factors on the technical front that identifies entry and exit points into such stocks and warning signs to look for according to his method. The TA aspects of O’Neil’s method are simple and will likely be the topic of a future blog.

Below are the highlights of the CAN SLIM system taken from O’Neils book The Successful Investor.

C = Current quarterly earnings per share: the higher, the better.

Primary factors :

· Should show a major percentage increase (18%-20% minimum) in the current quarterly EPS when compared to the prior year’s same quarter.

· Omit a company’s one-time extraordinary gains.

· Look for accelerating quarterly earnings growth.

Secondary factors:

· Look for quarterly sales growth of 25% or at least an acceleration in rate of sales percentage improvements over the last three quarters.

· Find at least one other stock in the same group showing string quarterly earnings growth.

A = Annual earnings increases: look for significant growth

Primary factors:

· The annual compounded growth rate for EPS should be at least 25%

· Significant growth in EPS for each of the last three years.

Secondary factors:

· The consensus earnings estimate for the next year should be higher than the current year.

· Return on equity of 17% or more.

· Look for annual cash flow per share greater than actual earnings per share by at least 20%

· Earnings should be stable and consistent from year to year over the last three years.

N = New products, new management, new highs: buying at the right time.

Primary factors:

· Look for companies with a major new product or service, new management, or a positive change for the industry.

Secondary factors:

· Look for stocks close to or making new highs in price after a period of consolidation.

· Strong volume on price move up.

S = Supply and demand: shares outstanding plus big volume demand.

Primary factors:

· Any size stock can be purchased under the CAN SLIM system.

· The market will shift its emphasis between small- and large-cap stocks over time.

· When choosing between two stocks, the stock with the lower number of shares should perform better to the upside, but can come down just as fast.

Secondary factors:

· Stocks with a large percentage of ownership buy top management are generally good prospects.

· Look for companies buying their own stock in the open market.

· Look for companies with a lower debt-to-equity ratio and companies reducing their debt-to-equity ratio and companies reducing their debt-to-equity ratios over the last few years.

L = Leader or laggard: which is your stock?

Primary factors:

· Buy among the top two or three stocks in a strong industry group.

· Use relative price strength to separate the leaders from the laggards –a stock with a relative strength rand below 70% is lagging and should be avoided.

Secondary factors:

· Look for companies with a relative strength rank of 80% or higher that are in a chart base pattern.

· Don’t buy stocks with weaker than average performance during a market correction.

I = Institutional sponsorship: follow the leaders.

Primary factors:

· Look for a stock to have several institutional owners. 10 might be a reasonable minimum.

· Look at quality of owners—seek out stocks held by at least one or two savvy portfolio managers.

· Look for stocks with an increasing, not decreasing number of sponsors.

Secondary factors:

· Avoid stocks that are over-owned—excessive institutional ownership.

M = Market direction

Primary factors:

· It is difficult to fight the trend, so try to determine if you are in a bull or bear market.

· Follow and understand what the general market averages are doing every day.

· Try to go 25% into cash when the market peaks and begins a major reversal.

· Heavy volume without significant price progress may signal a top, but initial market decline may be on lower volume.

· Follow market leaders for clues on strength of market.

Secondary factors:

· Look for divergences of key averages and indexes at major turns—divergence points to weaker and narrow market movement.

· Sentiment indicators may help highlight extreme psychological reversal points.

· The change in the discount rate is a valuable indicator to watch as a confirmation of market moves.

Peace and Profits to all

Friday, November 12, 2010

Stop Loss Selection

How many times were you taken out of a trade just before the stock turns around and takes off in your presumed direction with you as the spring board?  Not pleasant.  So when a friend of mine asked me to help with placing stops I wanted to be clear on the topic since stops are a key risk management skill that traders must have to survive this game.  This article talks specifically about stop losses, not for break even or stop with profits type exits.
The short answer is the same to many trading questions: it depends.  It depends on the style of trading, time frame, risk tolerance, etc.  That’s why system trading is very popular as the trading parameters; entries, exists, stop losses, stops, targets etc, are mostly pre-defined.
So let’s pick a specific scenario/system and take it from there: Swing trading days/weeks hold-time with buying support on signs of strength on the intra-day/daily/weekly/monthly charts review, using close prices.
You are at a point where you have identified your support levels and have your entry area with a good risk/reward ratio selected.  For picking a stop, you have to get familiar with the stock's personality first to see how it behaves around key levels: Look at the history of the stock, does it trade cleanly around key levels or does it violate it before it recovers?   This will help you decide your initial risk, whether to give your stop more room, use a soft or hard stop, or use that stock at all for that matter.  The cleaner the levels the better.
Keep in mind that key levels can also change from day to day when they are an active moving average.  Or when that moving average enters into the trading range of a stock that previously had clearly defined/drawn lines representing key levels, such as channels, breakout levels, etc.
Now that you have your support levels and are more familiar with the stock behavior, you can have a stop that’s lower than the support levels by roughly 0.5-1.5% depending on the price of the stock and how volatile it is.  On shorter term momentum holds, you can enter as close to the low of the day (LOD) as possible with a stop under the LOD.  Breaking the LOD+ and holding there is your signal that there’s more selling to come and the stock is not ready yet to bounce.  In this case either step aside and let the sellers finish their business or if there’s a good short setups play then take the short side of the trade with as many checks in your favor as possible.  Everything that applies for the long side the reverse applies on the short side, just make sure you are going with the trend in the time frame you are trading (many different topics here beyond the scope of this article.)
In addition, keep in mind that you do not have to stop out your entire position at a single level.  You can get out of your position in stages depending on your risk and the strength of the supports.  It does not have to be an all or none type trading depending on your style.
If you have any questions let me know. 
Peace and profits to all,