Having rules is the real key to being a good investor. Removing your emotions and following a system as if you’re a robot is the only way to improve your returns. Investors Business Daily is a great example of system trading. William O’Neill has created a strategy (CANSLIM) that supposedly outperforms the S&P 500 over the last 10 years by a wide margin. Although I don’t use the CANSLIM system I have to admit that I have stolen a few of their rules. Below are IBD’s 20 rules:
1. Consider buying stocks with each of the last three years’ earnings up 25%+, return on equity of 17%+ and recent earnings and sales accelerating.
2. Recent quarterly earnings and sales should be up 25% or more.
3. Avoid cheap stocks. Buy higher quality stocks selling $15 a share and higher.
4. Learn how to use charts to see sound bases and exact buy points.
5. Cut every loss when it’s 8% below your cost. Make no exceptions so you can always avoid huge, damaging losses. Never average down in price.
6. Follow selling rules on when to sell and take profit on the way up.
7. Buy when market indexes are in an uptrend. Reduce investments and raise cash when general market indexes show five or more days of volume distribution.
8. Read IBD’s Investor’s Corner and Big Picture columns to learn how to recognize important tops and bottoms in market indexes.
9. Buy stocks with a Composite Rating of 90 or more and a Relative Price Strength Rating of 85 or higher in the IBD SmartSelect® Corporate Ratings.
10. Pick companies with management ownership of stock.
11. Buy mostly in the top six broad industry sectors in IBD’s New High List.
12. Select stocks with increasing institutional sponsorship in recent quarters.
13. Current quarterly after-tax profit margins should be improving, near their peak and among the best in the stock’s industry
14. Don’t buy because of dividends or P-E ratios.
15. Pick companies with a superior new product or service.
16. Invest mainly in entrepreneurial New America companies. Pay close attention to those with an IPO in the past 8 years.
17. Check into companies buying back 5% to 10% of their stock and those with new management.
18. Don’t try to bottom guess or buy on the way down. Never argue with the market. Forget your pride and ego.
19. Find out if the market currently favors big-cap or small-cap stocks.
20. Do a post-analysis of all your buys and sells. Post on charts where you bought and sold each stock. Evaluate and develop rules to correct your major past mistakes.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Onlooker
I’m certainly no expert (on this system or investing in general) and won’t pretend to be so, but it seems to me that this system was built for the great bull market of 82-00 and produced great results in that market. It’s a momentum system that buys the stocks that are going up because they’re going up. Isn’t that so?
I don’t know about their record since ’00. Maybe it works in all markets, I don’t know.
Thoughts TPC?
Cullen Roche
I’m certainly skeptical of CANSLIM. As you said it seems to work great in a bull market and fail in a bear, I.e., a high beta strategy. I still like some of the rules though…