Cup And Handle Chart Pattern - CANSLIM strategy.
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How To Make Money In Stocks by William O’Neil.
O’Neil, founder of the stock brokerage firm William O’Niel and Co, creator of the CAN SLIM strategy and chairman of the publication Investor’s Business Daily.
In this book O’Neil presents 100 charts of the best performing stocks through to 2008. We look to discover the common attributes from the charts which led to their spectacular performance, of which some skyrocketed 20-fold in just a couple of years.
We offer a summary of the book and provide a template you can use to gain similar spectacular performance.
Let’s take a look.
We managed to pull all the 100 stock chart statistics together highlighting the return of each, the number of weeks it took to achieve the return, and perhaps more importantly the annualised return for each chart.
In a moment we will sort the companies in order of the highest annualised returns and look at the characteristics of the very best performing stocks, but first let us summarise the data.
The average return achieved per stock was 805% and the average length of time to achieve such gains was 95 weeks. This gave a spectacular average annualised return of 543%, or almost five and a half times your investment in a year.
We can see in this chart the best return achieved by a company was almost 7000%, all the way down to 210% here. Although these numbers seem impressive at first glance, we must consider the time period in which it took for these returns to materialise. We can do this by annualising the data.
On this chart we can see 6 stocks that achieved an annualised return considerably more than 1000%, a multiple of ten times your investment is an excellent achievement. The next part of this video is to focus on these 6 stocks to determine the commonalities between each, including the catalysts, the chart structure and perhaps more importantly the risk reward profile.
In sixth place we have a company called Resorts International, it achieved a 630% return in just 24 weeks which equated to an annualised return of 1365%.
Other than the annotations written on these weekly charts we are left with determining the reasons for entry ourselves, so let’s see what we can establish here.
First, we can see a Cup and Handle formation which the book refers to in some detail and is often the foundation for William O’Neils strategy.
O’Neil says cup patterns can last between 7 and 65 weeks, this example is approximately 28 weeks in total.
The “U” shaped area of the cup is important as it creates a strong foundation of owners unwilling to sell. The handle is usually the area of consolidation where a potential entry point could be determined along with a suitable stop loss.
In this example it seems the rising wedge is the catalyst, resulting from these inflection points.
The breakout of the wedge can be seen here at the suggested buy point. Thereafter the price increased 6-fold.
But where would the stop be positioned and what would be the eventual risk reward of this trade….
My suggestion would be below this small pull back under the resistance line of the wedge.
Using this stop loss distance as a measure of risk, we can see the risk reward of this trade equated to 19 to 1 assuming you sold at the climax top, this kind of ratio, when found often enough is where you can really change your account balance.
O,Neil also suggests a maximum stop loss position of no more than 8%.
As a quick example before moving to the next chart and using an 8% stop loss against a £10,000 position, we can assume an £800 risk on the trade. We also know the eventual reward was 19 times the risk, therefore the eventual return on risk was £15,200. A great return in just 24 weeks.
Next, we have a company called J D S Uniphase, the price of this stock rose 1946% in just 66 weeks.
O’Neil suggests that this was the Cup and Handle formation traded in the stock, the formation is a bit too subjective for me on this chart, but we can see the principle in action.
We can see at this buy point that the price broke out of the handle formation through some prior resistance. Also note how the weekly volume saw a spike at the point of purchase in comparison to the previous weeks low volume.
If we again assume a recommended 8% positional risk, the stop loss would be placed around here just below the handle.
We can therefore again calculate the risk reward ratio by following the price trajectory all the way up to the price of 125.
In this example the risk reward ratio would have been 16 to 1.
Again, using the 8% stop loss limit against a £10,000 position, we would have assumed £800 risk and returned a profit of £12,800 in just 66 weeks.
Before we move onto the next stock, lets quickly look at the importance of the risk reward ratio in terms of a trading strategy.
Using the two stock examples we have looked at, a ratio of 16 to 1 is used, we have therefore placed a risk of $100 and a reward of $1600.
We have assumed a win rate of just 20% meaning you can allow for 8 losing trades out of the 10 placed. In this example we make 100 trades and run the simulation 10 times to determine the possible outcomes.
The equity curves show the extremes of all the permutations, here we see the maximum return of almost $35,000 with very little drawdown along the way, and here the minimum return of $11,000.
Notice that the worst-case scenario is 27 losses in a row, this is an important metric because you can determine your possible drawdown based on the amount risked. Let’s say you risked 2% of your account on each trade, this would have equated to a drawdown of 54%. You could therefore perhaps conclude that a 1% risk per trade is more suitable to allow for your trading edge to materialise.
Ok, let us look at the chart in 4th place and see what William O’Nell suggests.
This chart is of Northern Pacific. Unfortunately, I see a lot of subjectivity here but let’s look nonetheless.
O’Neil sees a double bottom here and 18 weeks later a breakout, on high volume.
A stop loss position of 8% would likely be placed below the low of the buy candle.
There is also suggestion of a Cup and Handle formation here, but I am not convinced this is an obvious observation, I would be more inclined to say that this was a 10 week breakout from a period of consolidation, and a valid reason to add to the position further.
Clearly the chart exploded a few weeks later, but without an obvious sell signal we will leave the risk reward calculation alone on this example.
Moving quickly on to 3rd place, we have a stock called Qualcomm.
Qualcomm increased in price by 2091% in just a matter of 45 weeks, providing an annualised return of 2416%.
We can see again here William O’Neil recognized a cup and handle formation.
The pattern completed over a 24 week period.
We can also see here a resistance line, formed by these two previous inflection points.
It looks likely to me that O’Neil wanted to see a breakout of this resistance line with some conviction, confirmed by this volume spike here.
Not forgetting the recommended 8% stop loss around this area, we can then calculate the risk reward of this trade and follow the price all the way up to 180, at which point O’Neil suggests selling at the climax top.
The trade resulted in a risk reward of 23 to 1.
Again, using 8% of a $10,000 position, equalling a risk of $800, the profit would have been $18,400. Or, $400 a week for 45 weeks, not bad for an initial $800 risk….
Moving onto the two biggest gaining charts from the book, in second place we have the popular company Yahoo. From March 1997 shareholders looked in amazement as the stock made many of them very wealthy indeed.
Yahoo increased an incredible 6723% in 130 weeks, that is a 67! multiple of your initial investment.
Let’s study the chart to see which clues have been provided by O’Neil.
Here we see a large cup and handle formation which is formed over a 64 week period.
We can also see a double bottom within the cup.
A common trait amongst all the cup and handle formations, which is evident here, is the drying up of volume within the structure of the handle. This suggests an equilibrium between buyer and sellers and is often the calm before the storm.
We can see here a strong resistance line formed by two recent inflection points.
It could also be argued that another cup and handle formation could be drawn here within the structure of the former.
All in all, these combined factors made this a very interesting platform indeed.
However, O’Neil needed to wait for a catalyst before entering the trade, he seen it in the beginning of September just a few weeks after the setup was recognised.
It came in the form of a breakout above the resistance line, again on high volume.
Once again, we look for placement of a stop approximately 8% away from the purchase point, this would be somewhere here, just below the new support level.
We then wait to see if the trade plays out as expected. However, if you have seen our animation of Trading In The Zone by Mark Douglas you will know that the price could go in either direction, we are simply putting probabilities in our favour.
With our stop loss in place, we watch as the price increases many fold over the following weeks, and provides an eventual risk reward trade of 30 to 1.
The sell criteria had been achieved when a climax top was once again identified.
In this example, our $800 risk would have returned $24,000. Another great example.
Before we get to the final chart, please hit the like button, and subscribe for our library and future releases.
The stock chart with the biggest gain from all the charts presented in the book, is from a company called TASER International.
TASER grew an astonishing amount from June 2003 to June 2004, increasing from $1.50 to $108!
In this example O’Neil suggests that a big cup with handle base formed over a 4 month period, albeit with a small handle.
He once again seen a consolidation in price at the handle, followed by an increase in volume at the breakout. This became his catalyst and buy point.
He would have no doubt placed his 8% stop around the handle formation, and then watched the price explode upwards for the eventual return of 2228% and a risk reward of approximately 23 to 1. This time turning an $800 risk into $18,400 over just 39 weeks. Certainly a return you would have been pleased with…
Up to this point we have covered the top 6 performing charts, from a technical perspective, of the 100 presented in the book.
The common attribute from each of the charts and for the majority presented in the book, is that of the Cup and Handle set up.
To recap the classification of the cup and handle formation, O’Neil says the base length can be between 7 and 65 weeks, and the depth of the cup should range between 12% up to 33%.
The formation should also follow a prior uptrend of at least 30%.
A tightening of price should be seen at the handle, accompanied with low volume.
The entry point should be at the break of the pivot point supported with an increase in volume.
In theory, this set up tells us the bulls have taken over the market and any selling pressure has diminished.
The final piece, being the structure at the handle, allowing for a tight stop loss for excellent risk reward.
Neither the book nor the strategy end here, William O’Neil also includes many fundamental factors which he calls the Can Slim method. The method predominantly looks for growth stocks with momentum components, and once filtered, they can be merged with the Cup and Handle formation covered here.
We will cover the Can Slim method next in a separate, part 2 video.
I leave you with this quote from O’Neil which encapsulates the theory behind his methods.
“What seems too high and risky to the majority generally goes higher and what seems low and cheap generally goes lower."
See you again soon.