CANSLIM: A proven strategy for chart readers.
The cup or cup-with-handle
formation is a chart pattern that identifies stocks
preparing for a breakout to new highs or the start of a new
uptrend. This pattern in history has shown to be the most
popular in preceding a big move up in a stock's price. This
was popularized by William O'Neil (Founder of Investor's
Business Daily Newspaper) and his CANSLIM method of stock
picking outlined in his book, "How to Make Money in
The CANSLIM approach to investing
combines technical and fundamental analysis to identify
promising stocks in leading industries. According to the
system, only those stocks meeting a set of quantifiable
criteria are candidates for purchase. In addition, a stock
must exhibit one of three or four different chart patterns
that summarize less quantifiable aspects of the system.
The most common chart pattern used
in the CANSLIM system is called a cup-with-handle. The
pattern is so named because, when viewing a stock's price
chart, it takes roughly the shape of a cup. The price rises
to a peak and then falls (1), forming the left side of the
cup. From there, the stock trades sideways for some time,
then rises to form the right side of the cup (2). After
completion of the cup (3), before the stock breaks out to
new highs, the price often hits resistance and pulls back a
little (4). This pullback forms what looks like a handle.
The peak at the right side of the cup defines the buy or
breakout point, called the pivot price (5). This is now the
stop loss point or new support level. The breakout should be
confirmed with higher than average volume, preferable 25% or
greater, and the cup or cup and handle should be at least 6
weeks long and no deeper than 30% from top to bottom.
The C-A-N-S-L-I-M characteristics
are often present prior to a stock making a significant rise
in price, and making huge profits for the shareholders!
O'Neil explains how he conducted an
intensive study of 500 of the biggest winners in the stock
market from 1953 to 1990. A model of each of these companies
was built and studied. Again and again, it was noticed that
almost all of the biggest stock market winners had very
similar characteristics just before they began their big
C = Current quarterly earnings per share
They should be up a
minimum of 20% over the year earlier. In fact, of the 500
best performing stocks O'Neil studied in the 38 years from
1953 to 1990, three out of four had earnings increases
averaging more than 70% in the latest publicly reported
quarter before the stocks began their major price advance.
The one out of four that didn't show solid quarterly
increases did so in the very next quarter, and those
increases averaged 90%!
A = Annual earnings per share
There should be
meaningful growth over the last five years. The annual
compounded growth rate of earnings in the superior firms
should be from 15% to 50%, or even more, per year. With all
of this emphasis on earnings, it is important to understand
something about Price-Earnings Ratios (P/E). Factual
analysis of the greatest winning stocks shows that P/E
ratios have very little to do with whether a stock should be
bought or not! In fact, you will automatically eliminate
most of the best investments available if you're not willing
to by a stock that trades with a high P/E. In 1960, Xerox
traded at a 100 P/E - before it went up 3300% from $5 to
$170 (adjusting for the stock splits). Genentech was priced
at 200 times earnings in November 1985, and it bolted 300%
in the next 5 months. Syntex sold for 45 times earnings in
1963, before it advanced 400%. For years analysts have
misused P/E ratios, and it's amazing to me how so many
people will still ask about a company's P/E before they ask
about a company's earnings growth.
N = New product/management/price high. =
New product/management/price high
Usually it is a new
product or service that causes the big earnings acceleration
we're looking for. Consider these examples:
Tupperware division, in 1958, helped the stock go from $16
Thiokol came out with
new rocket fuels for missiles back in 1957-1959. The stock
blasted from $48 to the equivalent of $355.
In 1957-1960, Polaroid
came out with the "picture in a minute"
self-developing camera, the stock went from $65 to $260.
Then in 1965-1967 they came out with a color-film version.
The stock repeated with an amazing, split adjusted, rise
from $23 to $133.
Syntex, in 1963, began
marketing the oral contraceptive pill. In six months the
stock soared from $100 to $550.
advanced 1235% in 1978-1980, with the introduction of
Cad-Cam factory automation equipment.
Price Company went up
15 fold in 1982-1986 while opening their chain of wholesale
warehouse membership stores.
Get the point? 95% of
the greatest winners in the 38 year study O'Neil conducted
were companies that had a major new product or service.
The other important
thing to consider is the price of the stock. Most people
miss the biggest winners in the market because of what
O'Neil refers to as "the great paradox" of the stock
market. It is hard to accept, but the stocks that seem too
high and risky to the majority usually go higher and what
seems low and cheap usually goes lower. If you don't think
this is true, I challenge you to look in an old newspaper
from a few months ago and observe a good number of stocks
highlighted because they hit new highs and new lows. Then
see where they are today. Most of the highs will be higher,
and the lows will be even lower
S = Supply/Demand: Small Cap + Volume
Supply and demand
dictates the price of almost everything in your life. The
law of supply and demand is more important than all the
analyst opinions on Wall Street. The price of a stock with
400 million shares is hard to budge up because of the large
supply of stock available. Yet, if a company has only 2 or 3
million shares outstanding, a reasonable amount of buying
can push the price up rapidly because of the small available
supply. If you are choosing between two stocks to buy, one
with 60 million shares outstanding and one with 10 million
shares, with all other factors equal, the smaller one will
usually be the bigger mover.
Stocks that have a
large percentage owned by top management are generally
better prospects. Again referencing O'Neil's 38 year study,
more than 95% of the companies had less than 25 million
shares outstanding when they had their greatest period of
earnings improvement and stock price performance.
Foolish stock splits
can hurt a stock's performance. Watch out for companies that
split their stock 2 or 3 times in just a year or two. The
splitting creates a larger supply and may make a company's
stock performance more lethargic, like many "big cap"
companies. Large holders who thinking of selling are often
inclined to sell their 100,000 share positions before a
3-for-1 split would have them looking to sell 300,000. Smart
short sellers (an infinitesimal group) pick on stocks
beginning to falter after enormous price runups and splits,
realizing that the potential number of shares for sale
(particularly by funds) has dramatically been increased.
L = Leader or Laggard?
Which is your stock?
People often buy stocks they're comfortable and familiar
with, like an old pair of shoes. Usually these are lagging
slowpokes rather than leaping leaders. It is really
important to look at how your stock is performing in
relation to the overall market. The 500 best performing
stocks from 1953 to 1990 averaged a relative price strength
of 87 (scale of 1-99) just before they began their major
advances in price. Avoid laggard stocks and look for genuine
I = Institutional Sponsorship =
It takes big demand to
move a stock significantly higher in price. Institutional
buyers are the most powerful source. You don't need a large
number of institutional owners, but should have at least a
few. No institutional sponsorship in a stock is a bad sign
because odds are that many institutional investors looked at
the stock and passed it over. The things we are looking for
with C-A-N-S-L-I-M are really signs that the bigger money
(mutual funds, banks, insurance companies, pension funds,
etc.) is coming into the stock. See that there is a
better-than-average performance record by at least a few of
the institutional owners.
Another good thing
about some institutional sponsorship is that it provides
buying support for the stock. Beware of stocks that become
"over owned". By the time performance is so obvious that
almost all institutions own it, it is probably too late. Pay
attention to whether the number of institutional owners is
increasing or decreasing.
M = Market Direction = Market Direction
You can be right on
everything else, but if you are wrong about the direction of
the broad market you are still likely to lose money. The
best way to analyze the overall market is to follow and
understand every day what the general averages are doing.
They are difficult to recognize, but meaningful changes in
the behavior of the market averages at important turning
points is the best indicator of the condition of the whole
What signs should you
look for to detect a market top? On one of the days in the
uptrend, the total volume for the market will increase over
the preceding day's high volume, but the Dow's closing
average will show stalling action, or substantially less
upward movement, than on prior days.
The spread between the
daily high and low of the market index will likely be a bit
larger than on the earlier days. Normal market liquidation
near the market peak will only occur on one or two days,
which are part of the uptrend. The market comes under
distribution while it is advancing! This is one of the
reasons so few people know how to recognize distribution
the first selling near the top, a vacuum exists where volume
may subside and the market averages will sell off for four
days or so. The second, and probably the last early chance
to recognize a top reversal is when the market attempts it's
first rally, which it will always do after a number of days
down from it's highest point. If this first attempt to
bounce back follows through on the third, fourth, or fifth
rally day either on decreased volume from the day before, or
if the market average recovers less than half of the initial
drop from it's former peak to the low, the comeback is
feeble and sputtering when it should be getting strong.
Frequently the first attempt at a rally during the beginning
of a downtrend will fail abruptly. Possibly after a one-day
resurgence, the second day will open up strong, only to sell
off toward the end of the day and suddenly close down
After an advance in
stocks for a couple of years, the majority of the original
price leaders will top, and you can be fairly sure the
overall market is going to get into trouble. It is very
important to pay attention to the way the leading stocks are
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