First In A Series

Mistakes are the portals of discovery, wrote James Joyce, an author who didn’t know squat about stocks, but who maybe grasped the consequences of broken rules.

Investors who ignore even just one or two rules as they jump into stocks also often discover themselves caught up in a costly education. There truly are a lot of rules to learn when it comes to CAN SLIM investing. But it’s important to remember that every rule took shape as a solution to a problem.

Unlike most folks, IBD founder and Chairman William O’Neil studied his own past investing mistakes in search of valuable lessons. Many times, he would direct research teams to study precedents in other stocks or in the market. Using the data and the facts as a guide, he then devised a rule to prevent a repeat of that particular mistake.

Investor’s Business Daily is the sum of that experience. Still, it’s no secret that everybody gets tempted to at least bend the rules.

The first step to staying on track is to make sure stocks on your watch list meet some minimum requirements. A checklist to vet potential leaders is a good starting place for fundamental research. (See the accompanying graphic.)

It is often tempting, when stocks on your watch list begin to climb out of bases, to jump in early. Investors already holding a large profit cushion in a stock might add shares and make this a workable strategy. But this could also backfire.

The primary purpose of buying stocks as they exit valid bases is to synchronize your buying with the activity of institutional investors. This cuts your risk and makes your buying more consistent.

A big-volume reversal at the bottom of a base is a good sign. But an even larger investor may be waiting to unload shares when the basing stock hits a given trigger. Research shows that waiting for a buy point helps minimize that risk.

Another temptation in the current market has been to buy a stock that’s passed a perfectly formed buy point, but in weak volume. It’s hard at first to grasp that, no matter how perfect a pattern and a would-be breakout look, if volume does not climb more than 40% vs. its daily average, it typically does not turn into an authentic breakout.

It can be even harder to sit out a big-volume breakout occurring before the market moves into a confirmed rally. But the difference between a correcting and a rallying market may be the single biggest factor determining the level of risk you face.

Learning all the CAN SLIM rules takes time and effort. Following them requires discipline. The level of reward you earn from this system depends upon your degree of commitment on both counts.