Lessons from Market Legend William O’Neil On Relative Strength, Volume, Charts

How do you use relative price strength to pick stocks?

Restrict selection to stocks with Relative Price Strength Rating of 80 or higher. When you are trying to choose which two or three stocks to buy, we recommend preferring the one showing the best angle up in the relative price strength line on a chart. You never want to buy stocks with the relative price strength line in a general decline over the past six to twelve months.

What is volume and why is it important?

Stock prices do not go up by accident. A surge in buying demand is a must, and most of this demand comes from institutional investors who account for more than 75% of buying of the better quality leading stocks.

Funds are just like elephants jumping into a bathtub. They are simply so big the water rises and splashes all over the place.

As long as the fundamentals are solid, does it really matter when you buy a stock?

Timing is everything, and this is just as true in the stock market as it is in life. Charts are essential because they communicate critical information about how a stock is acting in the marketplace - information you would miss by concentrating on fundamentals alone.

As part of our study of stock market winners, we identified an optimal buy point or "pivot point" for a stock. This point, usually at the end of a sound basing area when the stock price breaks out into the new high ground, is the point of least resistance. This means that at this point, the stock has its greatest chance of moving even higher based on its current and historical price and volume activity.

When did O’Neil realize the importance of reading charts?

The evaluation of the purchases of an outperforming mutual fund led to this idea. The MF bought stocks only when they made new highs. What applies to buying merchandise on sale at a department store works in the completely opposite way when dealing with stocks. Ignore "buy low and sell high" and replace it with "buy high and sell a lot higher." Stock market winners always seem to be priced high because we only get to see their price history. The incredible gains to come are not yet visible and therefore high is rarely high when you are looking for really great companies.

What is investor psychology behind a double-bottom base?

The second leg down will drop slightly below the absolute low of the first bottom. This serves as a shakeout and helps wear out, or scare out, the last few weak shareholders. Volume dry-up and tight trading as the stock approaches its pivot price indicates there is no more selling coming into the market.

What is the single most important thing an investor should know?

Whether you are a new or experienced investor, the hardest lesson to learn is that you are simply not going to be right all the time. Brains, education, ego, stubbornness, and pride are deadly substitutes for having and following sound selling rules. Did you buy fire insurance on your house last year? Did your house burn down? If it didn't, were you upset because you wasted your money on the insurance? Will you refuse to buy fire insurance next year? You buy insurance to protect yourself against the remote possibility you could suffer a major loss that would be difficult to recover from. That's all you do when you cut short your losses.

What do you think? Please email us any questions or comments.

Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.