William O’Neil’s Investment Strategy
The best way to understand how a trader handles sales is to look at a specific system. One such system is outlined by American fund manager William O’Neil in his book How to Make Money in Stocks.
Taking trading losses
Whenever a stock is bought, a tight stoploss of 7-8% is set below the purchase price. No matter what the reason for the decline, each stock should be sold without hesitation if it drops down to or below this limit.
Stocks may also be sold if “you can sense that the market or your stock isn’t acting right or that you are starting off amiss”. That means, for instance, if there are signs that the overall market is going into a decline, or if there is evidence that steady selling by institutions is holding back the price of a stock.
The aim of this rule is to keep the average of all losses even lower than the stoploss, ideally down to about 5-6%.
Taking trading profits
In general, stocks should be sold
- if they do not show a profit of more than 20% within 13 weeks
- as soon as they have risen by 20%
O’Neil’s rationale here is that the prices of most growth stocks tend to move 20-25% before consolidating at higher levels. Stocks that do not rise by this amount within three months are probably faulty selections. Unless there are only temporary reasons for their sluggishness, they should be sold so that the cash can be profitably reinvested.
If, however, a stock rises 20% in less than 8 weeks, it should be held for 8 weeks and then analysed again to see whether it should be held for a long-term gain.
The aim here is to hold on to stocks that have particularly strong momentum, with the potential to make gains of several hundred per cent. For these longer-term holds, O’Neil specifies 36 different sell signals. Among the most important are:”Sell if a stock advance gets so active that it has a rapid price run-up for two or three weeks (eight to twelve days). This is called climax (blow-off) top activity.”
- “Consider selling if a stock runs up and then good news or major publicity is released.”
- “You may occasionally want to sell if a decline from the peak price exceeds 12% or 15%.”
- “When it’s exciting and obvious to everyone that a stock is going higher, sell, because it’s too late!”
These rules illustrate a key principle behind O’Neil’s system and those of many other traders. Namely, to follow the trend until sentiment towards a particular stock becomes too optimistic. Then you have to be an early seller: “The object is to get out while a stock is up, before it has a chance to break.”
*Remember that there is no magic formula in investing. William O’Neil’s Investment strategy has proven to work wonders, but it also has a probability of failing.Do your own homework and create your own investing strategy.
As seen in: Incademy