How to Make Money in Stocks: A Winning System in Good Times or Bad

O'Neil pulled the 500 biggest stock winners from 1953 to 1993, measured what they all looked like just before they ran, and compressed the answer into a seven-letter checklist you can apply in an evening. The screen has aged unevenly. The two chapters on when to sell have not aged at all.

The one idea

The book exists to break one habit: buying stocks because they look cheap. O'Neil ran the numbers on four decades of the market's biggest winners and found that almost none of them looked cheap at the moment they became buyable. They were making new highs. Their earnings were already exploding. Their price to earnings ratios averaged 20 while the Dow averaged 15, and those ratios then expanded another 125 percent on the way up. The stocks that looked like bargains, sitting on the new-low list at eight times earnings, mostly kept going down.

He calls this the great paradox, and he backs it with a survey of his own lecture audiences: 98 percent of individual investors told him they will not buy a stock making a new high. That single reflex, he argues, is what disqualifies most people from owning the stocks that actually move. A stock going from 50 to 100 has to trade at 51, 52, 53 first. Somebody has to be willing to pay 51.

So the whole system is built to identify strength and then buy more of it, not to find value and wait. Earnings acceleration tells you the business inflected. A new product or new management tells you why. A new price high off a proper base tells you the market agrees. Institutional buying tells you there is real money behind it. And a hard 8 percent stop underneath every position is what makes it survivable when the read is wrong, which O'Neil says it will be roughly half the time.

What it actually teaches

CANSLIM is seven screens applied in order, followed by two execution rules that decide whether you actually make money on the names that pass.

1. C: CURRENT QUARTERLY EARNINGS

   Earnings per share in the most recently reported quarter must be up at least 18 to 20 percent versus the same quarter a year earlier, never versus the prior quarter. O'Neil says many successful investors set the bar at 25 or 30 percent, and in bull markets he wants 40 to 50 percent and up. His justification: three out of four of the 500 biggest winners showed current quarter earnings up an average of more than 70 percent before their move began, and the remaining quarter did it the very next reporting period, averaging 90 percent. Only about 2 percent of listed stocks clear this at any given moment. He also insists you break six and nine month reports back down into single quarters, strip out one-time gains like a plant sale, and treat two quarters of sharp deceleration (a 50 percent growth rate falling to 15 percent) as a sell signal, not a dip.

2. A: ANNUAL EARNINGS GROWTH

   Annual earnings per share should rise every year for five straight years, with a compound growth rate of 25 to 50 percent or higher. He tolerates one down year only if the next year makes a new high. Reference numbers: winners between 1970 and 1982 averaged 24 percent annual compound growth at the emerging stage, median 21 percent, with one in four being turnarounds rather than steady growers. He adds an earnings stability score on a 1 to 99 scale where lower is steadier, and wants growth stocks under 20 to 25 (above 30 means cyclical and less dependable). Critically, both C and A must be strong at once. A company with a five-year 30 percent record whose last two quarters slowed to plus 15 and plus 10 is a pass, not a buy.

3. N: NEW PRODUCT, NEW MANAGEMENT, NEW HIGH

   More than 95 percent of the winners had a major new product or service, new top management, or a structural change in their industry. That is the reason the earnings inflected. The timing half of the letter is the harder rule: buy as the stock emerges from a price base and pushes into new high ground, not before, and never more than 5 to 10 percent above the exact pivot point. Bases run from seven or eight weeks up to fifteen months. His own study of new-high and new-low lists found stocks on the new-high list kept going higher and stocks on the new-low list kept going lower.

4. S: SUPPLY AND DEMAND

   Prefer a small share count. More than 95 percent of the winners had fewer than 25 million shares outstanding at the time of their run. The 1970 to 1982 top performers averaged 11.8 million shares with a median of 4.6 million. He also wants heavy management ownership, low long-term debt as a percent of capitalization, and companies buying back their own stock (Teledyne shrank from 88 million shares to 15 million and took earnings from 61 cents to nearly 20 dollars a share). On the demand side, the breakout day's volume must run at least 50 percent above the stock's normal daily volume, and often 100 percent or more.

5. L: LEADER, NOT LAGGARD

   Relative price strength is scored 1 to 99. Below 70 means the stock is lagging the market and O'Neil will not touch it. He restricts buys to 80 and above, and notes the really big winners generally read 90 or higher just before breaking out of their first or second base. The 500 best performers each year from 1953 to 1993 averaged a relative strength rating of 87 just before the move started. He is blunt about the failure mode: buying the cheap-looking second-best name in a hot group. He bought Syntex at a new high of 100 in 1963 for a 400 percent gain while the street pushed G.D. Searle as the cheaper sympathy play, and Searle went nowhere.

6. I: INSTITUTIONAL SPONSORSHIP

   You want some, not a lot. Three to ten mutual fund sponsors is his stated minimum. Institutional orders drive more than 70 percent of trading in leading companies and, by his estimate, 80 to 90 percent of significant NYSE price moves, so a stock with zero professional ownership will not move and will not be liquid when you need out. But a stock everybody already owns is what he coined as overowned, and that just means a large stack of potential sellers. What matters more than the count is the direction: is the number of sponsors rising quarter over quarter, and are the good funds the ones adding.

7. M: MARKET DIRECTION

   The letter he calls most important, and the one he puts last. Three out of four stocks follow the general market, so a perfect CANSLIM name bought into a topping market loses money. He rejects indicator stacks in favor of reading daily price and volume on the index itself. A top shows as distribution: higher volume than the prior day with the index stalling or closing down, repeated on a handful of days while the market is still rising. When that appears, raise 25 percent or more cash immediately at market prices. A bottom is confirmed by a follow-through day, an index gain of 1 percent or more on volume higher than the day before, arriving between the third and tenth day of an attempted rally, best on days four through seven. After day ten, treat it as weak. He notes bear markets averaged nine months and a 26 percent decline, but 1969 to 1970 ran two years and 36.9 percent, and 1973 to 1974 took the Dow down 50 percent while the average stock fell more than 70 percent.

8. BUY ONLY AT THE PIVOT

   The chart chapter defines where the pivot actually sits. The base patterns he wants are the cup with handle (7 to 65 weeks long, most three to six months, correcting 12 to 33 percent from peak to low), the saucer with handle, the double bottom, the flat base (at least six or seven weeks sideways, correcting no more than 10 to 15 percent), and the rare high tight flag (up 100 to 120 percent in four to eight weeks, then three to five weeks sideways correcting no more than 10 to 20 percent). The handle must form in the upper half of the base and above the 200-day moving average, and must not drop more than 10 to 15 percent. Any base needs a prior uptrend of at least 30 percent to be worth anything. Buy on the day the stock clears the pivot on volume 50 percent above average, and stop buying once you are 5 to 10 percent past it.

9. THE PROFIT AND LOSS PLAN

   This is the part of the book that carries its weight. Cut every loss at 7 or 8 percent below your purchase price, no exceptions, no waiting, sell at market. He wants your average realized loss to land at 5 or 6 percent because you often sense trouble earlier. On the upside, take the profit at 20 to 25 percent, because that is where breakouts typically stall and build a new base. The one exception: if a stock gains 20 percent in under eight weeks, hold it at least eight weeks, because that velocity marks the rare name that can run 100 or 200 percent. Never let a gain of close to 20 percent turn back into a loss. Give a stagnant position 13 weeks before concluding you picked wrong. Sell a leader when it closes a week below its 10-week moving average on increased volume, or when its relative strength rating drops below 70.

What it looks like Monday morning

You stop opening the position sizer and start opening a stop order. The single change this book makes to most people's Monday is that every buy now ships with a predetermined exit price written down before the trade, at 7 or 8 percent below entry, and a profit level at 20 to 25 percent above it. O'Neil's arithmetic is the argument: on three equal positions, two stopped out at 8 percent and one taken at 20 percent still leaves you ahead. You do not need to be right often. You need your losses to be smaller than your wins by a fixed, mechanical ratio you never renegotiate in the moment.

The second change is where you look for candidates. Instead of scanning for stocks down 40 percent that look cheap, you screen for the opposite: quarterly earnings up 25 percent or more against the year-ago quarter, five years of rising annual earnings, a relative strength rating above 80, and a price sitting within a few percent of a 52-week high after a multi-month consolidation. That combination is buildable in any free screener now. Then you check the index chart before you press buy, because the book's own claim is that three out of four of your picks will do whatever the market does regardless of how good the company is.

Wrong twice, right once, still ahead: this asymmetry is the entire reason O'Neil treats the 8 percent stop as non-negotiable rather than as a suggestion.

The whole secret to winning in the stock market is to lose the least amount possible when you're not right.William J. O'Neil, How to Make Money in Stocks

Who it is for

Reviewed here is the 2nd edition (1995). The link goes to the 4th edition, where O'Neil rewrote the S criterion away from the raw share-count threshold quoted above.