Success in the stock market needs careful selection of stocks, in contrast to forex trading and futures trading where success can come from a very small number of currency pairs or futures contracts, or even one, and is a matter of timing.  For many people, stock selection is hit or miss, so they rely on newspapers, tips or market gossip.  Indifferent results are almost inevitable from this approach.

What if there was a better way of choosing stocks, based on identification of the common characteristics of winning stocks back to 1953, drawing from both fundamental and technical analysis?  And what if the person developed it based on his experiences is a wealthy and successful stock trader who was in books such as “Market Wizards”?

There is such an approach, and this article will provide the details of how this trader selects his stocks for profitable trading.

The CANSLIM approach

William J O’Neill is a successful businessman, broker and trader and developed the CANSLIM approach after studying 500 stock market winners.  The goal of his study was to identify growth stocks before they make major price advances.

The system identifies stocks with strong fundamentals based around earnings growth for buying before they emerge from their price bases and increase in price.  CANSLIM essentially identifies mispriced stocks with the final trade occurring when the stock breaks out of its base.

CANSLIM is an acronym.  The letters stand for:

C - Current earnings per share.  The best stocks show a 70% average increase in earnings in the current quarter over the same quarter in the previous year.  Quarterly earnings should be up by at least 20-50% year to year.

A - Annual earnings per share.  Each year’s earnings per share should increase over the previous years.  For outstanding shares identified in the study, average annual compounded earnings growth for the five years was 24% before the shares increased in price.

N - Something New.  This could be a new product, new management, a change in the industry, or a new share price high.

S - Small number of outstanding shares.  The stocks that performed best had a small number of outstanding shares.  By definition, this means small cap companies.

L - Leader.  Buy leaders and avoid laggards.  In the study, leading stocks had a relative strength of 87 before the stock price increase began.  Relative strength is a measure of a stock’s price performance relative to other stocks.

I - Institutional sponsorship.  Institutional buyers (pension funds, mutual funds) move the market and leading stocks usually have institutional backing.  A good share should have some institutional shareholders in the registry.  However, if the stock is excessively owned by institutions, it is probably too late to make a big profit from it.

M - Market indices and trends.  Price movements for most shares are correlated with the direction of major indices, such as the S&P 500.  It is important to buy when the market is going up.

O’Neill states that about 2% of shares meet the CANSLIM criteria at any point in time.  He advocates use of charts in addition to the CANSLIM criteria to understand a stock’s price movements.  This allows the trader to determine when the stock is forming a new high.  This means that the trader should never anticipate a price increase, but wait for the breakout.

Risk control

When prices go down, you need to cut your losses quickly.  O’Neill never holds a share once there is a 7% loss.   In bear markets, you can lose a significant percentage of your holdings by continuing to keep shares while the price continues to fall.

He does not advocate over diversification, but being very selective, and thoroughly understanding and monitoring the stocks that you hold.

Conclusion

William O’Neill has produced outstanding results by carefully identifying the characteristics displayed by winning stocks prior to their price advances.  This is a combination of technical and fundamental criteria.  With web based filtering tools, you can quickly narrow down a list of stocks that meet the criteria, and then evaluate other characteristics such as whether the company has something new to offer, and whether it is breaking out of a price base before making the trade.

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Tags: CANSLIM, stock picking, stock profits, William J O'Neill

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