Friday, March 5, 2010

William O'Neil's Wisdom

William J. O'Neil

William J. O'Neil made his first investment of only $300 in Procter & Gamble while serving in the Air Force. After graduating from Southern Methodist University and a tour of duty in the Air Force, he began his career as a stockbroker in Los Angeles. While a young broker, O'Neil started studying historical stock market winners. He identified seven key characteristics all these leading stocks had in common before their big price advancements, and increased his personal portfolio over 2,000% in just 26 months. He went on to become a multi-millionaire as the founder of a prestigious brokerage and Investors Business Daily.

"The stock market is human nature on parade. "

"When the forgotten old dogs begin to bark and spearhead the market's advance, the stock market is on its last feeble legs."

"First, you must recognize that you are simply not going to be right all of the time... In a lifetime of investing, you'll probably only be right five or six times out of ten. So you absolutely must have a rule to always protect yourself."

"My rule is simple -- any stock that I buy that declines 7% or 8% below my actual purchase price, I will always without exception, sell to cut short my loss."

"Your first loss is always your smallest loss. The only insurance policy you can take out to protect against a large devastating loss is to cut them all without exception while they're still small. "

"I will never average down in price. If I bought at $50, I will never buy more at $45 or $40 -- that's risking more money in a stock that's already wrong and not working -- so why put more good money after bad?"

"The real key to stock market success is not to be right all the time (which you can't be) but to have more of your money in the stocks you're right on and lose less percentage wise and have fewer dollars in the stocks where you're wrong."

"Money is made by putting your eggs slowly and intelligently into fewer baskets you know well and watching those very carefully. Over-diversification is a hedge for ignorance."

"Our buy and sell rules were not based on our personal beliefs, systems, philosophy or opinions, but precisely on how the stock market actually worked for the last half century."

"It should be noted that Wall Street completely missed the homebuilders as a group with strong potential. Most leading firms all downgraded the group in the spring of 2001, saying they should be sold and that strength in housing sales couldn't last. The better housing stocks have since then doubled. Housing analysts gave costly advice."

"I have always avoided low-quality companies. As a rough definition, I place any company with a price below $10 in this category. You won't get the same quality of sponsorship (ownership by institutional investors) behind these companies that you do in true market leaders."

"Our research shows that most of the companies that had the best performance in the stock market started big runs with high earnings multiples."

"You absolutely must learn, write down, and follow some specific sell rules on when to best sell and take a profit on the way up while a stock is still advancing and popular. For example: If your stock breaks out of a sound price base structure and advances for many months and, on top of that, then runs up in price for one or two weeks at a much faster rate than in any other prior weeks since the beginning of the move up, this is a climax top, and the stock should always be sold while everyone else is all excited by the exceptionally strong price action. Typically, one day in this climax period will be up more points than any other day in the whole move up. Sell, get out while you can, and nail down your profit."

"How many times have you been wrong? When a stock is dropping, that's what the market is telling you -- "you're wrong." There are plenty of people who thought that Enron was severely underpriced at $30. Everyone needs sell rules, otherwise you're not being realistic. Nothing lasts forever. The big leaders in one market cycle do not normally come back and lead in the next bull market cycle. If you want to learn more about when to sell or how to create a realistic set of sell rules to improve your investment results, that includes being prepared to not fight the market. It doesn't care what you think about a company, or what you paid for it."

"Recognize this about the stock market -- it is a wonderful example of psychology on parade. It's a matter of historical fact that 82% of the best-performing stocks over the last 50 years had a blow-off top before they started coming down. I don't know about you, but if I saw something that happened 82% of the time, I'd pay attention."

"I did a study of the people that were doing very well in the market. I got copies of their prospectus and quarterly reports and plotted on charts precisely where they had purchased each of their stocks. There were over 100 of these securities and when I laid them out on a table, I made my first real discovery: Not some, not most, but every single stock had been bought when it went to a new high price. So the first thing I learned about how to get superior performance is not to buy stocks that are near their lows, but to buy stocks that are coming out of broad bases and beginning to make new highs relative to the preceding price base."

O'Neil says that certain changes in volume and price indicate selling or distribution. When institutions and professional investors start to sell, it means a trend reversal is imminent. He says most people miss these signs because they occur while the market is still advancing. But the signs, he says, are clear. They are:

  • The strong market leaders often sputter first, ahead of the general market.

  • Some low priced, low quality speculative stocks begin to move up.

  • The market averages have moved into new high ground.

  • Market volume increases while the price level stays the same or rises only marginally.

  • The Dow shows stalling action. This usually occurs in the third to ninth day of the advance.

  • There are often significant divergences between different market averages.

    These are the key factors, and O'Neil says one, notably the volume increase while prices falter, occurs on just one or two days, so if you miss it, well you miss it. But we do get a second chance. After these indicators occur and the market turns, O'Neil says the market will have an attempted bounce back. If the first attempted rally fails, it is a sign that a market reversal is in progress.

    How do we know a rally has failed? If the rally sputters in its third, fourth or fifth day, or if the rally recovers less than half of the market drop, it is a sign of market weakness. Another sign is if the first market resurgence ends abruptly on the second day with a strong opening in the morning but closing down at the closing bell.

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