Understand Basic of Stock Market and How it Works

William O’Neill first published “How to Make Money in Stock Market” in 2009, right after the market downturn, which was the financial crisis.

Even though the timing of the release could have been better, “How to Make Money in Stocks Market” has managed to sell 2 million copies.

O’Neill and his research team examine the best-performing stocks over the past 125 years. Their findings are presented in this book.

Contrary to much of the advice given earlier on this channel, O’Neill believes that timing the market, trading, and interpreting stock charts can significantly help your investments.

Basic of Stock Market

A stock market, equity market, or share market is the aggregation of buyers and sellers (a loose network of economic transactions, not a physical facility or discrete entity) of stocks (also called shares), which represent ownership claims on businesses; these may include securities listed on a public stock exchange, as well as stock that is only traded privately. Stocks are categorized in various ways. One way is by the country where the company is domiciled.

Takeaway Number 1: Follow Can Slim

Can Slim is a system for selecting stocks created by O’Neill. In short, each letter is an important factor to look for when buying a stock.

These are the characteristics that most winning stocks show in their early stages before they turn huge profits for their owners.

Let’s Understand CAN SLIM

C – Current Quarterly Earnings and Sales

This characterizes the winning stocks that stood out the most.

Graph showing Current quarterly earning sales.

Your shares should always show a large increase in current-quarter earnings per share compared to the same quarter last year.

Three of the four winning stocks gained an average of 70%. Use at least 20% as your limit. If growth is accelerating, that’s an even better sign.

Income growth should also be accompanied by an equal increase in sales.

A –  Annual income increases.
Stock market Annual earning increases with showing graph.

Also, look at the last three years of annual earnings per share growth to make sure the latest quarter isn’t just a fluke.

They should be up at least 25% on average per year.

N – New products, management or terms.
New products, management and conditions.

For a stock to make good progress, something new has to be done.

It can be an innovative product that either beats competitors or creates new markets. A new CEO who brings new, organizational behavior or changed circumstances in an industry such as supply shortages, wars, or new technology.

Stocks that have been market superstars over the past century fall into one of these categories in 95% of cases.

S – Supply and demand.

In a free market, the price is always determined by supply and demand. Lingonberry jam, Dala horse, salt licorice, cheese slicers, polka pigs, and princess cakes all follow this rule. And so stock up.

Look for a company that reduces its supply of stock through repurchase programs. Also, look for a company where top management asks for a piece of the company’s profit and show it by becoming a shareowner.

L – Leader or Backward.

Buy leaders, not backward. Aim to be the number one or number two company from a strong industry group.

Such a company has better quarterly annual earnings growth than its competitors. Remember: the first man gets the oyster, the second gets the shell.

I – Institutional Sponsorship

Do you remember what we said earlier about supply and demand? The largest source of demand comes from institutional investors.

Look for companies that have institutional owners, where some of them are among the top performers in the asset management industry, and where the number of institutions holding stocks has increased in the latest year.

When a fund establishes a new position, likely, it will later add to that position, leading to an increase in price.

M – Market direction.

You may be right about all six factors we just mentioned, but if you are wrong about the direction of the market, you will lose money in most cases anyway.

O’Neill stresses this part of CANSLIM so much that it will be…

Takeaway Number 2:

How do you determine the direction of the market? There should be something in your tool kit that can decide whether the general market is bullish (up-trending), or bearish (downtrading). Why?

Stock Market up trading and downtrading using bear and bull.

Because you want to invest solely during bull markets, perhaps even using some borrowing to increase your leverage, you want to free up cash and exit the market during bears.

The best signals you can get on up or down trends come from the major general market averages and their price and volume changes.

Market averages are displayed in the most commonly used market indices, such as:  

  • S&P Global 1200.
  • NASDAQ Composite.
  • OMX Stockholm Pi.

Follow the indices that are relevant to your specific stock. For example, if you own a company that operates in the US and is included in the Nasdaq Composite, that index is very important to you.

An index at a higher level of abstraction, such as the S&P Global 1200, is also OR value. On the other hand, OMX Stockholm PI takes on less importance in this case.

Here, I will list some of the indicators that O’Neill uses to evaluate whether we are in a bull or bear market. In bear markets, stocks are usually strong but weak. In bull markets, we see the opposite.

A bull market usually ends when there have been four or five days of “delivery” over a period of four to five weeks.

A day of distribution means that the stock market index has increasing trading volume, but the index shows a halted or negative price development.

Conversely, a bear market usually ends when an index is attempting to rally for three to six days and a “follow-through” occurs on the fourth to the seventh day. Rally attempt is defined as either closing at a higher price than the day before or recovery of a downswing from AM in PM.

Follow-through is defined as a day where prices differ (plus two percent preferred), combined with an increase in daily trading volume.

The market goes from bear to bull when most newspapers are painting the economy’s pitch-black future.

A change in the direction of the market can also be detected by evaluating the last four or five purchases you have made.

If you’re up to them all, it’s probably a bull market. If you haven’t made any money, it’s probably a bear market. In general, the more these indicators can be seen in the indices, the stronger the value of the signal.

Takeaway Number 3:

Buy shares from a strong base. In medicine, doctors consider charts such as EKGs, ultrasound waves, and the like. Atmospheric scientists study models and charts to predict the weather.

Politicians use charts and other data as a basis for making decisions about future laws and budgets. In almost every field, tools are available to help you evaluate situations and interpret information correctly.

The same is true for investing and your primary source of information here is stock price and volume patterns. Sometimes these shapes are healthy and strong, and are said to form a “strong base”.

Other times, they are weak and abnormal, creating a “weak base”. In O’Neill and his team’s study of the largest stocks in the latest century, one premise has been particularly profitable: “the cup with the handle”.

The cup with handle chart formation.

The cup with the handle looks like a cup with a handle (surprise, surprise!) when viewed from the side. The width of the cup, which is how long the base lasts, is usually 7-65 weeks.

The height of the cup, which is how deep it was before the stock bounced back, is usually 12-30%. If the fall was partly due to a general decline in the market, the highs could be even higher.

Unlike how you want to shape your shoulders, this cup doesn’t have to be shaped like a V. It’s better if it looks like you. This is because when the bottom of the cup is long, weak investors are forced to.

A solid foundation is thus established for less willing holders to sell during the next uptrend. OK, now onto the handle.

The handle should form into the top half of the cup as measured from the full top of the cup to the full bottom and flow downward, a so-called “shakeout”.

The handle should not move below the stock’s 10-week moving average. It usually lasts for more than two weeks.

After the handle comes to the “pivot point”, which is our buying point. Jesse Livermore, a great investor from the first half of the 20th century, coined this expression.

The pivot point occurs when the handle’s downtrend is broken upon a substantial increase in daily trading volume. Look for growth of at least 40 to 50%, but it is not uncommon for new market leaders to show growth of 200, 500, or even 100%.

This is a sure sign that professional institutions have started to take notice of the stock. Generally, you also want a price pattern to have at least a few weeks of “hardness,” which is defined as a small price variation from the week’s high and low.

Also, while the bottom of the base, which is under the cup and handles respectively, if the volume dries up it is a sign of strength. This means that the sale has ended.

You always want a stock price increase of at least 30% before this pattern appears, plus, trading volume must be up. “not my cup of tea!” He is alright.

Other price patterns are useful for buying – such as “cup without a handle”, “double bottom” and “flat base”.

The Takeaway Number 4:

1 time you should always sell your stock. The best offense is a strong defense, right? If you’ve ever attended PE classes at school, or watched a football game, you know this. In the stock market, this cliché is also true.

If you don’t learn to protect yourself from big losses, you absolutely can’t win the investing game! The secret to winning big in the stock market is not to be right all the time, but to lose the least amount possible if you are wrong.

But how do you know where you are wrong? easy! The stock price becomes less than the price you paid.

For each point, your preferred holding is reduced by the amount you paid, the risk that you are wrong, and the price you are going to pay for this to happen, increases.

So take every loss and drop 7-8%. There are no exceptions to this. Don’t wait a few days to see what happens. Do not expect the stock to rise.

Don’t wait for the market to close Remember: a 20% loss should be followed by a 25% profit at break-even.

A 33% loss requires a 50% gain. And at minus 50%, you have to double up. In other words, the longer you wait, the more maths will work against you.

Minimizing your losses is much better than waiting and expecting them to come back. Many of them don’t.

Takeaway Number 5:

There are 9 times you should consider selling your stock. Okay. Now you know what to do if your stock falls below your purchase price.

But if you limit your purchases to a stock that can pass CAN SLIM and that comes from a strong base, as the cup with the handle in takeaway number three, this should happen more often.

Basically, the question is “When do I accept my loss?” changes from. “When should I realize my profit?” I’ll tell you 9 situations in which you might consider doing this, but first, here’s a story you should consider.

 A little boy was walking down the street when he encountered a man who was trying to catch a turkey.

“I set up a trap with a box, a prop to hold the box in place, and a trail of corn that will attract the turkey to the bottom of the box,” the man explained.

“Once there’s enough turkey under it. I’ll pull the props and grab them!” “Although I can’t do it too quickly, because pulling the prop will scare away any turkeys nearby, and I only have one shot.” “Ah, simple enough,” thought the boy as he sat down to watch the man.

At one time, there were 12 turkeys in the bottom of the box. After a while one of them left, leaving 11. “Snap, I should have pulled when there were 12 of them!” The man complained.

“Let’s wait a minute and see if it comes back.” While he waited for the 12th turkey to return, two others left. “Oh, I must be satisfied with 11!” Another three went out. Still, the man did not pull, the boy watched.

Once he ate 12 turkeys, but he didn’t like going home with six. Ten minutes later, the box was empty, and the man returned home empty-handed.

Moral of the Story:

You have to establish a plan for when you want to realize the game. Don’t wait for your stock to return to its former highs. Instead, be humble, because you might lose it all.

 Now, here are 9 situations:

1.   Signals of distribution.
Signal of distribution in stock market with trading graph.

After a long advance, huge daily volumes indicate a distribution without further gains. Some of these days scream sell out over a short period of time.

2.   Stock split.

If the stock rises 25% or more within two weeks of a split, it is usually a huge profit. Time to pull the plug.

3.   Upper Channel Line.

A stock that rises through its upper channel line after a considerable run-up can usually be sold. You can draw an upward channel line connecting the last three high points of the last four to five months on a stock chart.

4.   New highs on poor volume
High and poor volume with graph in stock market.

If volume decreases, but the stock continues to rise, you may consider selling.

5.   Poor relative strength.

Is the stock not moving like the index it belongs to? This is a sign of weakness and usually means it is time to end it.

6.   Lone Ranger.

 A stock that is still faring within its industry group can mean two things:

1. It has eliminated all competition.

2. The industry group as a whole is facing tough times. Usually, this is the letter that happened.

7.   Closing at or near the day’s low.

Does the stock frequently close at the lowest price range of the day? So be careful!

8.   Slowdown in income.
Slowdown income with graph flow.

If earnings growth has been slowing for two consecutive quarters or more, there is a fundamental reason to sell the stock.

9.   Sell all the way down again.

You should always sell your stock if it moves too far from its peak. There is a huge difference between each stock, but a rule of thumb is somewhere over 12-15%. Note that it is normal for this to happen before one of the above selling points is reached.

Now, let’s summarize what this book has taught.

Advice Number 1:

Before buying a stock, make sure it passes the CAN SLIM test.

Advice Number 2:

Every investor should have the tools to decide whether we are in a bull or bear market.

This is important because using leverage in a bull market, raising cash in a bear market will increase your profits tremendously.

Advice Number 3:

Passing CAN SLIM for a stock is not enough for you to invest in it. The best opportunities arise from stocks that are also building a strong base, such as a cup with a handle.

Advice Number 4:

You should face reality and limit your losses when you are wrong. You do this by selling everything that is less than 7 to 8% of your purchase price.

Finally, Advice Number 5:

There are many situations where it’s time to realize your stock gains. Develop a system for it, and don’t be afraid to steal some of O’Neill’s time-tested methods for it!

Frequently Ask Questions

  1. Who Trades in Stock Markets?

    There are basically three groups of people who trade in stock markets. They are i) individuals, ii) institutions and iii) governments. For individual investors, it is as simple as making an investment decision to buy stocks listed on a stock exchange through their brokers and financial advisers.

  2. Understanding Key Terms in a Stock Market

    Looking to get in on that new hot IPO? Before you pull out your credit card, let’s start with some key terms related to stocks. When you buy stock in a company, you are purchasing part ownership of that business. So when a company releases more shares into its marketplace—to raise money, for example—it means that each share previously owned will be split among more shareholders.

  3. How does a Stock Market Work?

    A stock market, equity market, or share market is the aggregation of buyers and sellers (a loose network of economic transactions, not a physical facility or discrete entity) of stocks (also called shares), which represent ownership claims on businesses; these may include securities listed on a public stock exchange, as well as trading between dealers in private bilateral transactions (over-the-counter). Each dealer in this loose network has an inventory of stocks to sell.

Conclusion :

One final piece of advice from the author: It’s always the time to study and learn that you put in after 9-5, Monday to Friday, that ultimately makes the difference between winning and reaching your goals and missing out on really great opportunities.

I hope you have understood what the author wants to say about the stock market, if you have not started investing in the stock market then read the article on the stock market.

That can really change your whole life.

Cheers guys!

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