How to Make Money in Stocks: William O’Neil’s Method

William J. O’Neil is a significant figure in the investment world, widely recognized for his influential book, “How to Make Money in Stocks.” His methodology offers a structured approach for individuals seeking to navigate the complexities of the stock market. O’Neil’s strategy integrates both fundamental and technical analysis to identify promising investment opportunities. This system provides a framework for selecting stocks and determining optimal entry and exit points.

The CAN SLIM Stock Selection Method

The core of William O’Neil’s stock selection process is encapsulated in his CAN SLIM acronym, a seven-part methodology designed to identify companies with high growth potential. Each letter represents a specific characteristic present in leading stocks before they experience substantial price appreciation. Investors can apply these criteria to filter through numerous companies and pinpoint those exhibiting the desired attributes.

The “C” in CAN SLIM stands for Current Quarterly Earnings Per Share (EPS), emphasizing strong, recent profit growth. O’Neil looks for companies reporting current quarterly EPS growth of at least 25% compared to the same quarter in the previous year. This metric indicates a company’s business is thriving and expanding its profitability.

Following current earnings, the “A” represents Annual Earnings Per Share, requiring a history of consistent and significant annual EPS growth. O’Neil seeks companies with annual EPS growth rates of 25% or more for the past three to five years. This sustained growth trajectory signals a robust business model and management’s ability to consistently deliver increasing profits.

The “N” in CAN SLIM signifies New Products, New Management, New Highs, or a New Industry. This component highlights innovation, fresh leadership, or stocks breaking out to new price highs as indicators of strength and future growth. A stock reaching a new 52-week high, especially on increased trading volume, suggests institutional investors are accumulating shares, signaling strong demand. This “newness” often provides the catalyst for significant price movements.

The “S” addresses Supply and Demand, focusing on the relationship between a company’s available shares and buying interest. Companies with fewer shares outstanding can see their prices rise more rapidly when demand increases. Furthermore, significant price advances on heavy trading volume indicate strong institutional support and conviction. Observing daily trading volume alongside price movements helps gauge this dynamic.

“L” stands for Leader or Laggard, urging investors to focus on market leaders. O’Neil advocates investing in stocks that demonstrate superior price performance, often measured by their relative strength (RS) rating. A high RS rating indicates a stock is outperforming the majority of other stocks in the market, signifying its leadership position. Identifying these leaders involves comparing a stock’s price performance against the broader market and its peers.

Institutional Sponsorship is represented by the “I,” referring to the presence of institutional investors like mutual funds, pension funds, and hedge funds holding a company’s stock. Ownership by a growing number of reputable institutions is a positive sign, as these entities conduct extensive research before investing. However, O’Neil cautions against companies with too many institutions already owning shares, as this could limit future buying demand. Examining a company’s shareholder reports can reveal institutional ownership trends.

Finally, the “M” in CAN SLIM stands for Market Direction. Understanding the prevailing market trend is paramount for determining when to deploy capital, as a rising tide tends to lift all boats, including leading growth stocks.

Analyzing Market Direction for Optimal Entry

Understanding the overall market direction is important for O’Neil’s methodology, as even strong stocks can face headwinds in a declining market. This emphasis on market timing helps investors avoid significant losses and optimize entry points. The broader market trend dictates the probability of success for individual stock picks.

O’Neil assesses the market trend by analyzing the behavior of major market indexes, such as the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average. He observes their daily price and volume action to discern whether the market is in a confirmed uptrend, downtrend, or correction. This daily analysis provides insights into institutional buying and selling activity.

A key signal for a confirmed market uptrend is a “follow-through day.” This occurs during an attempted market rally when a major market index closes significantly higher on volume greater than the previous day. A follow-through day confirms institutional money is re-entering the market, signaling a favorable environment for new purchases.

Conversely, O’Neil identifies “distribution days” as signals of potential market weakness and institutional selling. A distribution day occurs when a major market index closes lower than the previous day on higher volume. A cluster of distribution days can indicate institutions are quietly selling their holdings, suggesting the market is under pressure and potentially heading for a correction. Recognizing these days helps investors determine when to reduce exposure or avoid new purchases.

This continuous assessment of market direction provides a filter for investment decisions. Even if a stock meets all the CAN SLIM criteria, O’Neil advises against buying if the overall market is in a confirmed downtrend or correction. Waiting for a confirmed uptrend increases the probability of a successful investment, as stocks tend to follow the broader market’s trajectory.

Implementing O’Neil’s Selling Rules

While O’Neil’s methodology provides a framework for selecting stocks, his selling rules are equally important for capital preservation and profit realization. These rules aim to minimize losses quickly and lock in gains, preventing significant drawdowns or the erosion of profits.

A fundamental component of O’Neil’s risk management is the 7-8% stop-loss rule. This rule dictates that an investor must sell a stock if its price falls 7% to 8% below their purchase price, regardless of initial conviction or the stock’s fundamental outlook. The rule’s purpose is to cut losses quickly and protect capital from larger, potentially devastating declines.

For taking profits, O’Neil suggests selling into strength when a stock has made significant gains, often around a 20% to 25% increase from the purchase price. The general guideline is to secure profits once a substantial move has occurred, preventing a profitable position from turning into a loss if the stock reverses.

O’Neil also emphasizes selling on weakness or signs of distribution, even if the 7-8% stop-loss or profit target hasn’t been met. This includes observing increased trading volume on down days for an individual stock, similar to market distribution days. Such activity can signal institutional investors are selling their shares, indicating the stock’s upward momentum may be faltering. These signals provide early warnings to exit a position.

The principle behind O’Neil’s selling rules is to consolidate gains and protect against significant capital erosion. By systematically cutting losses and taking profits, investors can maintain a healthy portfolio and free up capital for new, more promising opportunities.