What does the ‘M’ in CANSLIM stand for?
*This is an update to an article I wrote in the past*

According to William O’Neil (www.investors.com) , it represents the overall health and direction of the major market indexes. It is very important to understand and recognize what type of market you are in before you ever place a position (this may not include day traders but is extremely important to trend traders). How can you realistically make money and set goals based on a blind strategy without knowing if the current market is in bear mode, bull mode, up-trending, down-trending or if it is trading sideways. The market trades sideways with only slight deviations from an average about 80% of the time. This leaves us with a market that trends up or down with sustainable swings only 20% of the time. Three-quarters of all listed stocks will follow the general direction of the major indexes which include the NASDAQ, the DOW and the S&P 500.

By ignoring the ‘M’ in CANSLIM, your portfolio may get hit with losses if you are trading on the wrong side of the trend. Simply picture a river and understand that it is much more difficult to swim up-stream than it is to swim with the current downstream. The stock you buy may have a nice basing chart pattern and excellent fundamentals but it may come under pressure and move in the opposite direction you anticipated due to the general market weakness and/or sector weakness. The same can be said in a bull market; a stock that is a sub-par performer may act strongly and give the investor solid gains due to sector strength and/or overall market strength but the gains are primarily due to sister force (in this case, a bit of luck helped your position).

Study the market and you will see that stocks move in groups and many of the stocks in a strong industry will move in tandem. The same holds true for weak markets; if you own a stock in an industry that is starting to churn or breakdown, it may be wise to pull in a portion of you position to lock in gains before the bottom drops. More times than not, the leading stock in an industry group must conform and move in the direction of the others. A perfect example was the home builders, they have moved in tandem for the past eight years. If you look at their weekly charts over the past decade, you will see that they all have the same patterns but with different numbers. The image provided is from a case study I did back in 2005. Nothing has changed from 2005 to 2008 as this industry is still traveling the same road (most recently that was down).

As many of you know, I also use the daily new high and new low ratio (NH-NL) to compliment the overall strength that the market is presenting. The price and volume alone can fake out many investors and lead them down the path of faulty investing. In order for the market to be a formidable bull, the NH-NL ratio must compliment the general outlook and present us with at least 500 new highs per day on a consistent basis. When both the NH-NL ratio and the ‘M’ in CANSLIM are strong, we can justify placing larger positions (maximum 1-2% portfolio risk) and label the market as a bull.

William O’Neil, the founder of Investor’s Business Daily, states that many of the most profitable stocks over the past 50 years made their advances when the overall market was strong, not weak. The NH-NL ratio is always comprised of the strongest stocks in the current market and we know that these individual leaders are responsible for the bulls and the bears.

How can an investor monitor the market action to tell if it is weak or strong?

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We start the week by studying stocks that are currently building bases. I decided to specifically narrow the list down to stocks that are building cup shaped bases. Each stock presented today contains respectable fundamental characteristics such as strong earnings and revenue. Many, if not all of the stocks below have been covered within the past 6-12 months on the blog. A few of the stocks listed are building their first major bases since their spectacular up-trends in 2007.

Each stock has gained support along the 200-d (40-week) moving average while building their current base. The market has been moving higher but many pundits are calling this positive move a “head-fake” or slight pause in the main trend which is down (in their opinion). I couldn’t tell you if they are correct but buying stocks while they make new highs during a suspect market can be costly if it reverses. I prefer to buy stocks making new highs during an obvious up-trend. In any event, let’s go over a few technical rules for stocks building cup or saucer shaped bases.

On the weekly charts:

• Look for more up-weeks than down-weeks while the stock is building the base.
• Make sure that the volume is higher during the up-weeks than the down weeks.
• Volume should be below average or lighter during the down-weeks than they are during up-weeks.
• Stocks tend to make 3-5 bases during a long run over a few years. Be careful with stocks making late stage bases (4th base or later); they are more vulnerable to failure as most of the “smart money” (institutions) have rotated their cash into new stocks.
• Sell if a stock breaks out from a base on above average volume but suddenly reverses below the pivot point (ideal entry) that same day or a few days later.
• Beware of stocks trying to make news highs on above average volume but fail to end the day in the upper half of its daily range. This may be a reversal and a possible red flag.

Read an article I posted last January on How to Calculate a Stock’s Pivot Point:

How to Look for a Cup with Handle (chart #1):

Look for relatively quiet volume as the stock builds the left side of the cup. Volume at the base of the cup should be slightly higher than the left side as support is coming into the stock. The right side of the base should have above average volume with more up-days than down days. The handle will be the last part of the formation and should slope slightly downward with lower volume than the right side of the base. The pivot point will be slightly higher than the highest point of the right side of the base. All breakouts should occur on volume 100% greater than average daily volume although IBD does say that breakouts above 50% do qualify.

How to Look for a Saucer with Handle (chart #2):

Look for relatively quiet volume as the stock builds the left side of the saucer. A saucer looks similar to the cup-with-handle but the dip from the high to the low is smaller and usually longer in duration. Volume at the base of the saucer should be slightly higher than the left side as support is coming into the stock. At this point, the base may almost qualify as a flat base. The right side of the base should have above average volume with more up-days than down days but this does not have to be as prominent as the cup-with-handle. The handle will be the last part of the formation and should slope slightly downward with lower volume than the right side of the base. The pivot point will be slightly higher than the highest point of the right side of the base. All breakouts should occur on volume 100% greater than average daily volume.

All stocks and charts are listed in alphabetical order:

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Advancers lead decliners by a 17-to-1 ratio on the NYSE Tuesday and 10-to-3 on the NASDAQ. The DOW was up 3.5% with the NASDAQ up 4.2% making it seem like we had a follow-through but volume was lower. Besides, the NASDAQ violated the reversal range intraday on Friday and then again this past Monday. Because of this violation, the count had already reset and Tuesday’s huge gain acts as day 1 for a new rally. I know this can be confusing but it makes sense after you study the rules and then watch it happen over several years.

We can’t call this a follow-through on day 6 for the DOW because trading volume dipped from yesterday’s totals. The count does not reset because we have not violated the intraday low from the reversal day or day 1 of the rally attempt. Leading stocks didn’t do much to lift the market today so it is better off that we didn’t have a suspect follow-through. Rebounding financial stocks lead the market higher, not something we can hang out hats on.

Read up on the CANSLIM rules if you don’t completely follow what I am talking about when it comes to reversals, rallies and follow-throughs.

Past CANSLIM Articles:

• CAN SLIM Breakdown
• IBD’s 20 Rules for Success
• Understand the ‘M’ in CANSLIM

I am not getting overly excited about the 3.55% move in the DOW, the 3.98% move for the NASDAQ and the 3.71% jump for the S&P 500. Today’s action does raise some interest but trend reversals and new bull rallies can’t be confirmed after one day of action. All major bull markets started with a reversal and then a follow-through within the next four to ten trading days.

This idea was first revealed by William O’Neil, the founder of Investor’s Business Daily, and became a cornerstone in his CANSLIM investing method. I believe this theory to be accurate but it is not an exact science. Before I describe this method, I would like to be clear that my indicators are still pointing down and my screens are still focusing on shorts. It’s a good time to write about reversals and follow-through days even though I don’t think this rally has legs but my opinions must be checked at the door.

The key to understanding this follow-through philosophy is that reversal signals usually occur after a significant market correction, not a minor market correction. The reversal and follow-through in 2003 was classic and one I like to refer back to when looking at the present market. Both the reversal and follow-through days must move at least 2% to the upside on above average volume.

If today acts as day 1 of a possible reversal, then the next two days are not very important except for one fact: the market must not undercut today’s low as that would kill the start of a new rally. As long as prices stay above today’s low, the rally attempt is safe.

The follow-through day should come within four and ten days of today’s reversal although O’Neil’s original rules stated that the follow-through should come between day 4 and day 7. One of the major indexes must move higher by 2% or more on larger volume than the previous day to qualify for a follow-through. Multiple indexes participating with a follow-though shows conviction that the market has sustainability to move in the new direction.

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I wrote an article on October 15, 2007 titled How to Make Money Selling Short, precisely when the general market indexes were topping. I am not going to take full credit but subconsciously my charts were giving me signals that the market was showing the major red flags and signals of what we are seeing today. This is a direct quote from that blog post from three months ago:

I have (privately) screened several potential shorts over the past couple of months but this market is not ready to roll over just yet. I was early with my shorting analysis in 2006 so I do not want to make the same mistake in 2007. However, more and more stocks seem to be building bases like the ones from the bubble burst in late 1999 and early 2000 (examples in the charts provided).

When I short stocks, I look for longer term trends, not short term swing trades (rarely ever day trades). The shorts I want look like the charts in this post (they take months or even years to complete). I want the high flyers that will be crushed over the next several months. Just as I like riding trends higher, I like riding trends lower over the intermediate to long term (4-12 months). I am trend trader at heart and it is what I do best.

We will have bounces to the upside over the next few months and the Fed will try to stop the bleeding but the stocks that are due for crushing blows will be dealt those blows eventually and we all can profit from them. Stocks may move 20%-50% (in both directions) at times so be careful. I will spend the remainder of the week posting up charts that look ready to become long term losers. Charts similar to the examples below. Give the charts time to form, be patient because many of these will look to move higher at times (as soon as this week and next) prior to their inevitable fall.

Complete Blog Post Repeated from October 15, 2007:
The title of the post is borrowed from the book “How to make Money Selling Stocks Short” by William J. O’Neil. It’s an ideal book for investors that focus on trading longer term trends and don’t necessarily do this for a profession (i.e.: day traders).

The book contains some excellent strategies for finding prime shorting candidates or stocks that are about to enter a declining stage that may offer excellent risk/reward setups for buying put options.

(CLICK FOR LARGER IMAGES)

I consider several of the techniques in the book to be reverse CANSLIM? Study the charts from the past that have setup ideal shorts and then screen for those same characteristics in stocks trading today. Many of the ideal shorts from past market declines have held the reverse characteristics of an ideal CANSLIM stock (that you would want to buy).

Many traders believe that the most obvious area to place a short would be near the peak of stock’s trading range but studies have found this to be untrue.

Characteristics of Longer Term Trend Shorts

• Most ideal longer term “trend” shorts take four to twelve months after the peak price to setup on the weekly chart with the majority of these shorts triggering between six to nine months.
• Look for stocks that had prior up-trends and support levels that can now act as downward resistance or entry areas.
• Once a stock tops and starts to consolidate, you want it to slice through the 50-d moving average and then the 200-d moving average.
• A crossover between the 50-d m.a. and the 200-d m.a. is ideal and is graphically presented on each chart in this post
• The odds of success increase with each failed attempt for the stock price to recover these major long term moving averages.
• Head and shoulder tops can also serve as ideal setups for potential shorts if they take at least five months to develop.
• A decreasing relative strength line and a negative pattern on the point and figure chart can also confirm that the stock is rolling over and setting up an ideal short.
• Finally, volume should be increasing and the stock should be under distribution as it violates the major moving averages and starts to break former support levels.

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