Trade Like a WILLIAM O'NEIL Disciple is a book written by Gil Morales and Dr Chris Kacher, both of whom worked under O'Neil.
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Welcome back.
Today we look at the book; Trade Like an O’Neil Disciple, featuring Dr Chris Kacher and Gil Morales.
Both traders previously worked under William O’Neil at William O’Neil & Co and later generated thousands of percent by following William O’Neil’s trading method.
O’Neil is best known for his Can Slim strategy and the Investor’s Business Daily newspaper.
We look at the path both Morales and Kacher took to earn such outstanding returns.
The returns for Dr Chris Kacher reached over 18,000%, equating to a 110% annual return over a seven-year period between January 1996 to December 2002, in effect turning a $10,000 investment into 1.8 Million dollars.
Classed as William O’Neil’s right-hand research man Kacher examined years of stock behaviour, through more than 20 market cycles going all the way back to the 1920’s.
He came up with a list of criteria which all the best performing stocks shared, whilst also creating a market timing tool which has been accurate since 1974.
From his research and subsequent application, Kacher suggests that making big gains in the market need not be difficult, and continues by saying:-
“In the end, it is about working hard to put yourself in the position of being in the right place at the right time; that is, when a leading stock is just starting a huge upside price run”.
The quote gives us a flavour of Kacher’s philosophy which is supported by his first investment back in 1996, through a technology company called Iomega.
The stock saw a 700% increase in earnings and a 287% increase in sales, as a result the stock price broke through a significant line of resistance, although failed to break through the 200-day moving average.
This created a new line of resistance, and in mid-March price broke through both the resistance and the 200-day moving average with considerable volume.
Kacher proceeded to take a trade at the breakout with a 25% position size against his trading account.
The criteria he used is not ground-breaking, the best traders look for a catalyst which is often found from increases in earnings or sales. The same applies to the technical criteria, with most looking for breakouts of resistance with price trading above the 200-day moving average on increased volume.
The approach is clearly aligned to that of William O’Neil’s hybrid method which looks for fundamentals in combination with specific technical criteria, often referred to as a techno-fundamental approach.
Kacher also provided a chart which gave reason to sell his position in Iomega.
He notes that the stock price closed below its 10-day moving average, a rule he uses for most of his positions.
The trade eventually provided a return of close to 200% over a 3-month period.
Kacher suggests having such a sell rule in place can take the emotion and subjectivity out of trading, he says;
“Buy based on both fundamentals and technicals, but sell purely on technical, technical action should always be the final judge when selling a stock”.
Between March and June 1996 following similar methodology, Kacher found himself holding between 12 and 18 positions on full margin. He often used between 15% to 25% of his trading equity per position, therefore his use of margin would have been a maximum 4.5, so for every $1 of equity, he could have been controlling up to 4.5 dollars.
If we used his average position size of 20% against 15 positions its likely he would been using a margin of 3, or for every $1 of equity he would be controlling a more reasonable 3 dollars of stock.
In my opinion use of such high leverage requires significant levels of cash reserves or exceptional risk management, ideally both.
Kacher’s 18 positions were also heavily weighted with stocks displaying the Cup and Handle setup, a strategy we covered in previous videos.
To recap, during a correction or under the weight of a down trending market, the left-hand side of the cup is often formed, classed as such by a minimum prior advance of 30%.
The forming of a double bottom at the base of the cup is often a defining characteristic.
Once the weight of the overall market disappears, leading stocks start to appear, rebounding to levels to where they were heading before the tide of the market took hold, whilst forming the right-hand side of the cup.
A retracement prior to an eventual break of resistance offers an excellent place for a stop loss, just below the pivot point.
Other defining characteristics consider the depth of the cup, which should range between 12 and 33%, and the base of the cup which can be between 7 and 65 weeks.
A considerable increase of volume through the pivot point is also desirable.
These low risk high reward cup and handle patterns enabled Kacher to build a portfolio of high-quality leading stocks with considerable leverage.
At the end of June after accumulating his portfolio, Kacher soon found himself in a 100% cash position, after all the positions triggered his 10-day moving average sell rule.
Soon after the indexes started to fall, with the Nazdack index falling 20%.
Named the ‘Dr. K’s Market Direction Model’ Kacher describes how he timed and re-entered the market in early August 1996, a tactic he developed through his years of research and endorsed by William O’Neil, who went on to say:-
“Don’t ever let anyone tell you that you can’t time the market. This is a giant myth passed on mainly by Wall Street, the media, and those who have never been able to do it, so they think it’s impossible.”
Let’s look at the criteria for Dr Kacher’s timing model and how he used it to re-enter the market on the long side after a market correction.
Using a major index, first we need to see a rally attempt off the lows.
We can see there were two rally attempts, the first was seen in July. It was classed as a qualifying rally attempt due to price closing lower against the previous day, accompanied by the closing price being within the top half of the day on increasing volume. This rally attempt is a signal of potential supporting action off the lows.
The next action to look for is a follow through day. A follow through is determined by an increase in price of more than 1.5% from the previous day, with an increase in volume from the previous day.
We can see in this first rally attempt that although price achieved a 1.5% gain on the previous day, the volume was less than the previous day. This resulted in a failed rally attempt.
The next qualifying rally attempt appeared later in July, however the 1st follow through attempt failed due to volume again being less than the day prior. A few days later the market increased by at least 1.5% and this time it was accompanied by an increase in volume from the previous day. It was therefore a qualifying signal to re-enter the market with qualifying positions.
Kacher continued to buy individual stocks which again met his techno-fundamental criteria, and ended 1996 with a return of over 121%. He said:-
“As a general rule, following the method of buying fundamentally strong stocks at the right pivot points, then moving to cash when the market is weak puts the odds greatly in your favour”.
I tested the timing model against the S&P 500 index during the recent pandemic crash of 2020.
It’s likely we would have been put into a 100% cash position due to the positions crossing below the 10-day moving average. At this stage we look for a re-entry based on the timing model.
First, we look for a rally attempt. In late February we see the first rally bar defined by price closing below the previous day and closing within the top half of the trading day. Next, we look for a follow through day of at least 1.5%, which we get, although the volume is less than the previous day, therefore the signal is not valid.
The next rally attempt is seen a few weeks later in March, the bar has arguably closed within the top half of the trading day, followed by a follow through day greater than 1.5%, and this time with greater volume than the previous day. This could have been a valid signal and a time to build a portfolio of qualifying stocks.
Gil Morales under the same mentor as Dr Kacher took a similar path applying the same principles. In this example he takes us through his Oracle Corp trade.
Using the weekly chart, we are presented with a cup and handle formation, a resistance line and a breakout which signalled the 1st entry.
If we overlay the following chart, we can see the entry point and trade progression.
The 1st entry at the break of resistance from the cup and handle formation is seen here. It came after some tight consolidation with an increase in volume.
Several weeks later the stock again consolidated and formed what Morales referred to as a base on base formation.
The stock again broke out of consolidation through resistance and on significant volume, making new highs thereafter. Morales took a near 250% return in 3 months.
Referring to his Oracle trade Morales said:-
“The idea that stocks that try to break out before the general market has finished correcting and turning back to the upside are often your strongest buy candidates once the market actually does begin a new uptrend”.
In summary, the strategies of Dr Kacher and Morales are naturally aligned to William O’Neil’s. Both look for quality stocks often showing increases in earnings and sales, and like most successful traders they look for breakouts on volume in the direction of the trend, often determined by the 200-day moving average.
Both have sell rules which reflect a change in momentum to the downside, often closing below a moving average.
Other advice from the book includes, “buy expensive, not cheap stocks”, “Never average down a losing position”, “cut losses quickly”, “Allow your winners to run”, and “never listen to opinions, news or tips”.
The book is a recent discovery of mine and comes highly recommended.
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Financial Wisdom