CANSLIM

Understand the ‘M’ in CANSLIM

October 31, 2008 By Chris 7 Comments

Happy Halloween!

What does the ‘M’ in CANSLIM stand for?
Allow this post to serve as a reminder of our studies of the market in the past. I speak about the ‘M’ in CANSLIM many times throughout the year because of it’s great importance.

According to William O’Neil (www.investors.com) , it represents the overall health and direction of the major market indexes (Dow, NASDAQ and S&P 500). It is very important to understand and recognize what type of market you are in before you ever place a position (specifically trend traders). How can we 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 about 80% of the time so this leaves us with sustainable trends roughly 20% of the time. Three-quarters of all stocks will follow the general trend of the major indexes so don’t try to swim against the current.

By ignoring the ‘M’ in CANSLIM, your portfolio may get hit with losses by 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 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).

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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Filed Under: CANSLIM, Education, General Market

Pivot Reversal – Day 1

October 29, 2008 By Chris 8 Comments

I think…, I predict…, I expect…, They said…, etc…

Everyone is an expert when it comes to the market, or at least a certified psychic. Everyone seems to think they know what’s supposed to happen, especially if you read the articles around the web and the newspapers on the stand.

You know what I think: Talking heads are useless!

Why don’t we just sit back and allow the market to tell us where it wants to go. I can’t say that expected the market to rally more than 10% or almost 900 points the exact morning I post the parameters to a pivot reversal (the article was written Monday night while watching the Titans smack around the Colts).

In any event, the market clearly marked day one of the attempted rally. No argument here.

Is it too early? Should we wait on the sidelines? Should we wait for the election? Are you scared to trade? Are you scared to lose? Are you embarrassed to be wrong?

Rule #1: Wait for a follow-through on overwhelming volume, 4-10 days from today’s 10% surge. The signal will be “buy” if we get a follow-through, so add a few shares at that time. Maybe it will reverse but we can’t think to hard about rules etched in stone, so we can only act based on the historical odds presented by this scenario. Trade small; enter a position that is 1/3 or 1/2 of your regular position size or trade fewer units but don’t sit on the sideline because you “think” this is a false move.

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Filed Under: CANSLIM, Education, General Market, Technical Analysis, Wall Street

How to Spot a Market Reversal

October 28, 2008 By Chris 7 Comments

Before we get into screening individual stocks, let’s refresh our memories and understand what we are looking for in the major market indices: We are looking for a market reversal or as Jesse Livermore called it, the pivotal point.

“Whenever I have had the patience to wait for the market to arrive at what I call a “Pivotal Point” before I started to trade; I have always made money in my operations” – Jesse Livermore, 1940

Market direction or the ‘M’ in CANSLIM as I have highlighted it in the past is the most critical characteristic to consider when investing. Seventy five percent of all stocks follow the general market averages with these numbers becoming more skewed in times of extreme pessimism (like now – 90% of all stocks are following the carnage).

Bear markets are necessary to help deflate the overvalued price/ earnings ratios and overpriced shares in times of extreme exuberance. Bear markets create widespread negativity, overwhelming pessimism, fear, uncertainty and a total lack of confidence among investors. Cash exits the stock market as people panic like sheep and prices start to adjust back to reasonable levels, paving the way to new opportunities around the corner.

We are clearly looking for a new uptrend that sustains some life with a rally on above average volume. Bear markets will provide several head fakes as they typically fall in multiple waves of lower highs and lower lows. It usually takes the majority of stocks listed on the exchanges to sell off enough that a true base can form that will propel the next up-trend or bull market.

Study the charts below for the down-waves prior to the 1982 and 2002 bull markets. I selected these two years because they represent the strongest up-trends (bull markets) following a bear market over the past 30 years.

The first rally will feature one or more of the major market indices gaining at least 3% or more on higher volume than the previous day. It is then critical for at least one of these indices to follow-through with similar action four to ten days later (preferably four to seven days later – rules from original O’Neil books).

We won’t be able to tell if the market is building a rally after the first 3% up-swing so give it time and look for at least one, if not multiple follow-throughs from the four day on. The more, the better. Markets will give head-fakes about 1/5th of the time after a true follow-through so we will pay careful attention to the number of waves down during the current bear market. We have had three waves down but only one major wave down on the DOW (it could go lower – easily, before moving higher).

See charts below for the pivot point reversals and follow-throughs for the 1982 and 2002 bull markets.

We must understand that head-fakes and multiple pullbacks are clearly in the historical descriptions of former bear markets. I don’t quite know if the current markets have had sufficient pullbacks before launching a new up-trend (see the charts of the DOW and NASDAQ from yesterday’s post).

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Filed Under: CANSLIM, Education, General Market, Technical Analysis, Wall Street

‘M’ in CANSLIM

May 13, 2008 By Chris 6 Comments

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).

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

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Filed Under: CANSLIM, Education, General Market

Stocks Building Bases

April 28, 2008 By Chris 1 Comment

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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Filed Under: CANSLIM, Daily Stock Screens, Stocks, Technical Analysis