William O´Neill, a Stock Market Magician

I am going to talk about William O´Neill´s interview in the book The Market Wizards. O´Neill was a fantastic stock trader, and everybody who is interested in stock trading should read this interview. His view about stocks differed quite a lot from the typical consensus about PE ratios and dividends.

O´Neill was also a writer and entrepreneur, being the founder of investor´s daily, one of the most famous trading and stock market newspaper.

William O’Neill quotes

He said things like:

Not some, not most, but every single stock had been bought when it went to a new high price

This is very difficult to understand for many people who approach this world of trading. Many investors and traders think that the best is to buy “cheap” stocks. But actually the best is to buy stocks that are trading higher. Cheap stocks may remain cheap for very long time.

So, our first basic rule in stock selection is that quarterly earnings per share should be up by at least 20 to 50 percent year to year.

It was one of the keys to his strategy. The majority of stocks he chose were small and medium caps by the way.

But if I buy at exactly the right time, the stock is usually not going to go down to my maximum 7 percent stop loss point.

That is the stop loss order he used to place. A 7% stop loss gives room for the stock to maneuver and even fall a bit before going up. By 7%, he did not mean that he risked 7% of his account, because his account was composed of many stocks; so he diversified a lot. He may lose ten trades, but makes it right in four of them and win a lot more.

Another way to determine the direction of the general market is to focus on how the leading stocks are performing. If the stocks that have been leading the bull market start breaking down, that is a major sign the market has topped.

Every good investor or trader, since Jesse Livermore, knows that when the leaders break their bull trend the market is likely to reverse and go south.

A stock should never be sold short because its price looks too high. The idea is not to sell short at the top but at the right time.

And that right time is no other than when the stocks and the overall market have broken their primary trends, like the moving averageHe was not keen on shorting the market though.

No, because I never take unlimited risk. If a short position goes against me, I will be out after the first 6 or 7 percent loss.

William O’Neill trader

You have to use stop loss always when playing with stocks. Unlimited risk exists when you short a stock, since its price rise has no limit.

The goal is to make substantial profits on your stocks and not be upset if the price continues to advance after you get out.

This is another way of saying let your profits run, but at the same time tells you that after they have risen significantly it is not a bad idea to take the profit and be tranquil. If the stock keeps going up do not worry, for it could, as well, have gone down.

To say that a stock is undervalued because it is selling at a low P/E ratio is nonsense. In our research, we found there was a very low correlation between the P/E ratio and the best-performing stocks. Some stocks had P/E ratios of 10 when they started their major advance; other had P/E ratios of 50.

This is a very interesting paragraph. In O´Neill´s opinion, PE ratios were not that important. He like things like earnings growth or to try to buy stocks that are not popular, and do not have many people interested in them.

I still remember in 1962 when an investor barged into my friend´s brokerage office, declaring in a load voice that Xerox was drastically overpriced because it was selling at fifty times earnings. He went short at $88. Xerox eventually went to $1,300, adjusting for stock slpits.

That is why we should not pay too much attention for P/E ratios concerning individual stocks. You should never go short because a stock has a high P/E ratio, but because it is falling.

If you have five or six straight losses, you want to pull back to see it is time to start moving into cash.

When the overall market starts to break its bull trend a bull investor will face many consecutive and simultaneous losses in his stocks. If he is intelligent enough, he will sell on time and get out of the market before the crash comes.

A good way to ensure miserable results is to buy on the way down in price.

Shorting a stock that is going up is a very precarious business, as Huge Hendry once said.

Stocks are like anything else. You cannot buy the best quality at the cheapest price!

Once in a while I tried to buy cheap stocks. It ended up being a very expensive activity.

Most rumors are false, and even it a tip is correct, the stock ironically will, in many cases, go down in price.

You know, you should never follow tips in the stock markets.


P.S. This is a personal translation from my spanish blog www.brokerparacompraracciones.com. Thanks for reading and for sharing.