Book Reviews, Trading

Book Review of 24 Essential Lessons for Investment Success by William J. O’Neil

This is another book that I picked up written by WON. The style of the book is pretty interesting. The book is organized into 24 chapters / lessons. Each lesson is written in a Q&A manner, similar to an interview of WON, followed by a summary at the end of the chapter.

What is different about this book compared to other materials I have read from WON, is that this book goes into pointing out where to find the required information in the IBD paper. It is a bit like a how-to guide for using the IBD paper, which I think is helpful for people who are new to reading the IBD paper.

Much of the material in the book is already covered by many other IBD materials. Some interesting new bits include the 10 traits of successful people, and selling when the stock goes 2 to 3% above its channel.

One thing on pyramiding is that one part of the book wrote that the 1st pyramid occurs when the stock is up 2.5% to 3% from the first buy. Previous mentions of this ‘rule’ gave the range of 2% to 3%. In terms of actual implementation, my thoughts are that you want to see the 2.5% gain being held before you pyramid. Either enter towards the close of the market when you see that the 2.5% gain is held, or look at the action the following day, and enter if the 2.5% gain is holding and the stock is moving higher.

I have attempted to classify the tidbits into a few sections below: stock selection, position entry, position exit, money management, portfolio management, reviewing market action, psychology, and others. There is also a list of recommended books to read towards the end.


Do not go for low-priced stocks just because they appear cheap

  • Of the best-performing stocks of the last 45 years, the average per share price before they went on to double or triple or more was $28 a share. This is a historical fact. Cheap stocks involve far greater risk.

Key fundamental criteria

  • Annual EPS growth rates of 30% or more for each of the past 3 years.
  • Earnings in each of the last 6 quarters up 50% or more compared to the same quarter the year before.
  • Sales should either be accelerating in the last few quarters or be up 25% or more from the same quarter one year earlier.
  • ROE of 20% or more.
  • #1 in their particular fields in terms of recent sales and earnings growth, profit margins and return on equity.
  • Management owned a decent stake in the company.
  • Unique or exceptional new product or service that is perceived to  be superior.
  • Strong institutional sponsorship
  • Be in a leading industry group.
  • Owned by many better-performing mutual funds, banks and other institutional investors.

Restrict your stock selection to stocks showing a Relative Price Strength Rating of 80 or higher

  • Relative Price Strength Rating is obtained by taking a stock’s price 1 year ago and its price today, calculating the % change and then comparing it to all other stocks over the same period.
  • In our studies of all outstanding stocks since 1953, the average Relative Price Strength Rating of these superperformers at the beginning of their huge increases of several hundred to several thousand percent was 87.
  • True leaders will probably show a Relative Price Strength Rating of 85 or higher.

Look for stocks in a leading industry group or sector

  • Sectors are much broader than industry groups. It’s clear that stocks tend to move in groups or sectors.
  • Since 1953, the majority of individual stocks that were the real market leaders were also part of a leading industry group or sector at the time.
  • When I  buy a stock, I always like to see at least one other stock in the same group that is also showing strength.
  • Look for stocks in the top 20% of IBD’s 197 industry groups. The stock’s Industry Group Relative Strength Rating should be A or B.
  • Avoid stocks in the bottom 20% of IBD’s 197 industry groups.

Where to find the market’s leading industry groups

  • IBD’s “52-Week Highs & Lows” feature, which is organized by sectors with the most stocks making new price highs.
  • When you’re in a positive market with numerous stocks making new highs, the top five or six sectors in the list will be your leaders.
  • I check out this list every single day so I’m always aware of what the top groups are and can spot when a brand new group shows up in the top part of this innovative list.

Spot whether the market is focusing on large-caps or small-caps

  • It pays to be alert and invest where the big money is flowing. You want to go with the flow and not fight current market trends.
  • You can tell when the market shifts from small-caps to big-caps by tracking the small chart entitled ” Small-Cap Growth Funds vs. Big-Cap Growth Funds,” published daily on IBD’s “Mutual Fund Performance” section.

Look at what the top funds are buying

  • IBD’s Mutual Fund section shows top-performing funds. Every fund is compared using a 36 Month Performance Rating. A fund with an A+ rating is in the top 5% of all funds. An A is in the top 10%, an A- in the top 15%, a B+ in the top 20% and son on.
  • Also shown are a fund’s top ten new buys in the recently reported period in order of the largest dollar commitments. I am particularly interested in the top 3 or 4 new purchases. Where a top-performing fund places its largest buys tells you where it had the most conviction.

The best companies sell at much higher P/E ratios

  • We built models of all the outstanding stocks during the 1990s. At the very beginning of their 500% to 1,000% advances, their P/Es averaged 31 times earnings. And most of these leaders, on average, expanded their P/Es to the low 70s as they had their huge price increases.

Where to get investment ideas in IBD

  • “Where the Big Money’s Flowing” at the beginning of the NYSE and Nasdaq tables. Scan the boldfaced names.
  • Go through the NYSE and Nasdaq tables, from A to Z, only scanning companies shown in boldfaced type.
  • Scan company names on the “Best Ups” list in “Earnings news.”. This section highlights companies showing the biggest increases in quarterly earnings just reported.
  • Check the “10 Largest U.S. Holdings,” the “Top Sells,” and particularly the top 2 or 3 stocks on the “Top New Buys” list of the 2 or 3 mutual funds that have performed strongly for the year.


Why not buy at the bottom of the cup? The Risk is Higher

  • The objective is not to buy at the cheapest price when the probability of the stock having a huge move may be only so-so.
  • The objective is to buy at exactly the right time — the time when the chances are greatest that the stock will succeed and move up significantly.
  • I found through our detailed historical studies that a stock purchased at this correct “pivot point,” if all the other fundamental and technical factors of stock selection are in place, will simply not go down 8% (your protective sell rule), and has the greatest chance of moving substantially higher. So ironically, if done correctly, this is your point of least risk.
  • On the day the stock breaks out, its trading volume should increase at least 50% above its average daily trading volume.

Pyramid your initial buy

  • After your initial purchase (50% of your full position), identify a price area at which you will add a small amount as a follow-up buy if it continues to perform well.
  • I usually add more once a stock is up 2.5% to 3% from my first buy (32.5% of your full position).
  • If the stock advances 2% or 3% more, you may complete your position (17.5% of your full position).
  • Then stop buying that stock. You’ve got your basic position in the stock during its first 5% advance. Sit back and give it some time and room to grow.


Sell into climax tops

  • About 30% of market leaders will peak with a “climax top” after many months of advance.
  • The climax top will probably show the stock’s greatest one-day price advance since the beginning of the move up. Sell into this unusually strong price action.

Sell when a stock’s P/E ratio increases by 130% or more

  • You might also consider selling when a stock’s P/E ratio increases 130% or more from the time the stock originally began its big move out of its initial base pattern.

Sell when the stock exceeds its upper channel by 2% or 3%

  • Some of your stocks may be sold when the stock’s price goes through its upper channel line by 2% of 3%.
  • The upper and lower channel lines of a stock are determined by drawing a straight line connecting three of the price high peaks and a second parallel line connecting three price lows during the same period.


Use 8% as your absolute loss limit

  • I use 8% below my purchase price of the stock as the absolute limit I’m willing to lose.
  • Overall, your average loss will actually be less because in a few instances you can recognize when a stock is not acting properly before it drops 8% below your cost.

Do not let a winning position turn into a loss

  • Once my stock goes up in price a reasonable amount, I will seldom let myself lose money on the stock.
  • Let’s say my cost is $50 per share and the stock runs up to $58 or $59. If by some chance, it comes all the way back down to $50.5 and I didn’t take my profit when I had it, I’m certainly not going to let myself make a second mistake and wind up losing on something I had a worthwhile gain on. I’ll usually sell it at that point to avoid a loss.

Avoid getting shaken out of a potentially outstanding stock

  • About 40% of stocks you buy will pull back near your initial buy point — sometimes on big volume — for one or two days. As long as your loss-cutting point has not been reached (8% below cost), sit tight and be patient. Sometimes it takes a number of weeks for a stock to slowly take off from its launching pad. Big money can only be made by waiting.
  • You stock may pull back in price to, or slightly below, its 50-day moving average line for a day or two. This is normally a potential buying opportunity.
  • Don’t ever sell and take a profit if your leading stock runs up 20% or more in only two or three weeks. You must be patient and give your stock more time. Big price advances always take time to develop, so allow it at least 8 or 10 weeks from your first buy, then look at it again.


Three out of four stocks will follow the market’s trend

  • The reason you need to carefully evaluate these indices is that when they top, then turn down and go into a significant decline, three out of four stocks (whether you think they’re good or bad) will follow the market’s trend and also decline in price.

Basic conditions determine the length and depth of a bear market

  • Basic conditions in the U.S. and the world usually determine the length and depth of a bear market.
  • When the U.S. is in real trouble (depression, world war, Vietnam war, OPEC oil price increase, rampant inflation, etc.) you tend to get corrections of 30% to 50% in the Dow Industrials.
  • When basic conditions in America are not as bad, you get smaller market declines of around 17% to 27% off the peak.
  • Strangely, many of these declines end in the fourth quarter of the year.

Leaders are first to advance to new-high ground when the market turns

  • The major price advances of all the stocks I’ve mentioned [i.e. the winners] followed periods of price correction and base-building in which the prices made no real progress.
  • These chart bases were almost always formed specifically because of a decline or correction in the general market averages.
  • In each case, when the market finally turned, had a clear “follow-through,” and began a new uptrend, these leaders were the first stocks in the market to advance into new-high ground.
  • New big winners emerge during the first 10 to 15 weeks of a new bull market.

Spotting Tops: Four or five days of distribution over a two- or three-week period can turn a market into a decline

  • After 4 or 5 days of distribution (selling), the general market will normally turn down.
  • 4 days of distribution, if correctly spotted over a 2 or 3 week period, are often enough to turn a previously advancing market into a decline. Sometimes distribution could be spread over 6 or 7 weeks if the market attempts to rally back to new highs.
  • In general, distribution is indicated by the index closing down on increased volume or a day’s attempted advance stalling (very little change in price) on greater volume than the day before.
  • When I see 4 clear distribution days, I will start looking for stocks that are giving indications they should be sold or trimmed back. If you’re invested on margin, your risk can be twice as great — so sell and get off margin, otherwise you can get seriously hurt.
  • [My note: IBD will usually change a “Confirmed Uptrend” status to a “Uptrend Under Pressure” after 6 distribution days, and change to a “Market in Correction” at the 7th distribution day or later.]

Spotting Bottoms

  • Fake rallies
    • At some point on the way down, the indices will attempt to rebound or rally. Bear markets normally come in 2 or 3 waves, interrupted by several attempted false rallies that usually fizzle out after 1, 2, or 3 weeks and occasionally 5 to 6 weeks or more [my note: created by both bargain hunters as well as big players going for the short squeeze].
  • Counting rallies and follow-throughs
    • 1st day of an attempted rally is when the index closes up from the prior day (doesn’t matter if the intraday low is lower than the prior day).
    • If the intraday low of the 1st day of the attempted rally is undercut in the subsequent days, then the rally fails and the count is resetted back to zero.
    • As long as the days after the 1st day of the attempted rally stay above the initial intraday low of the 1st rally day, you are still in the rally process.
    • Look for a “follow-through day” in the 4th to 7th days (inclusive) of the attempted rally. A “follow-through day” is when the index closes up 1% or more with a jump in volume from the day before. Market is then in a new uptrend.
    • “Follow-throughs” after the 10th day indicate the turn may be acceptable, but somewhat weaker.
    • An initial “follow-through” can occur on any one of the indices and is usually followed a few days later on another index.
  • False signals
    • About 20% of the time they [the follow-through method] can give a false buy signal, which is fairly easy to recognize after a few days, because the market will usually promptly and noticeably fail on large volume.
    • Most true “follow-throughs” will usually show strong positive action on good volume either the day after the “follow-through” or several days later. Convincing power and strength is what you want to observe.

How to check the market’s health

  • Look at the daily evaluation of the 3 key indices
  • Look at the IBD’s Mutual Fund Index which tracks the performance of some of the best money managers. It shows how leading funds are faring and can give clues to the general market’s health.
  • Observe the behavior and action of the leading stocks in the market.
  • Unreliable indicators
    • Advance/Decline Line has frequently been known to give premature signals, way before a market’s eventual top. It also can show false weakness at some bottoms when the market is actually turning up.
    • Overbought / oversold indicators
    • Total number of new high prices vs. new low prices
    • Up-down volume
    • On-balance volume
    • Buying power vs. selling pressure
  • Moving averages and trend lines are mainly a waste of time and an unnecessary distraction.

A Fed rate cut may not lead to, or be necessary for a bull market 

  • A lowering in the rate can generally signal a new bull market.
  • But this indicator is not as reliable as really knowing how to interpret the market index changes.
  • For example, two bull markets developed with no Fed rate cuts, and three times (in 1957, 1960 and 1981) the Fed lowered rates and the market continued to go down.


Number of stocks that should be held in portfolio

  • If you have $5,000 or less, you should own no more than 2 stocks.
  • If you have $10,000, 2 or 3 stocks is appropriate.
  • With $25,000, 3 or 4 stocks.
  • With $50,000, 4 or 5 stocks.
  • With $100,000 or more, you should own 5 or 6.


Do not get discouraged and quit

  • I once had a string of ten stocks that I cut losses on. But the very next one emerged just as the market came out of a correction (downtrend) and more than tripled in price.


Never sell a domestic, diversified growth stock mutual fund

  • There’s only one real secret to success when you acquire a mutual fund. It’s something not everyone understands or has the patience to implement. It’s easy: You never, ever sell a domestic, diversified growth stock mutual fund. You hold it until you die, so to speak.
  • If you need income, just set up a monthly or quarterly withdrawal plan to take out 7% or 8% each year.

Ten traits of successful people

  1. Positive thinking. They think of success, not failure, regardless of how difficult the situation.
  2. Makes conscious decisions regarding what they’re after, and draw out specific plans to reach their goals.
  3. Action-oriented.
  4. Never stop learning.
  5. Being persistent and hard working.
  6. Analyze details and seek out all the facts.
  7. Focused, doesn’t let other people or things distract them from their goals. Learns to save money.
  8. Being innovative.
  9. Communicate with others effectively
  10. Integrity.

Recommended books

  • Gerald Loeb’s Battle for Investment Survival
  • Edwin Lefevre’s Reminiscences of a Stock Operator
  • Jesse Livermore’s How to Trade in Stocks
  • Bernard Baruch’s My Own Story
  • Humphrey Neil’s Tape Reading and Market Tactics
  • Burton Cane’s The Sophisticated Investor
  • Nicolas Darvas’ How I Made Two Million Dollars in the Stock Market
  • Peter Lynch’s One Up on Wall Street



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