Monday, July 22, 2013

How to Make Money in Stocks: Getting Started

Occasionally I make a point of reading books or articles whose messages are at odds with my own thinking. Every once in a while this leads me to change my thinking, such as when I decided to stop picking stocks and focus on low-cost index investing. It was in this spirit that I read How to Make Money in Stocks: Getting Started.

Author Matthew Galgani, co-host of the How to Make Money in Stocks radio show, seeks to show new investors how to use a particular system of short-term trading. This system, called CAN SLIM, primarily involves chart reading in an attempt to make money riding the momentum of stocks on the rise.

A positive for the system described in this book is that it is quite specific in a number of ways. In many cases is gives precise rules on when to buy or sell stocks. For example, the author says “if a stock drops 7% to 8% below what you paid for it, sell.” The author also gives some precise buy and sell prices based on stock chart patterns.

Unfortunately, there are enough competing trading rules in this book that when you try to apply them to real stock charts, you usually end up with ambiguous signals. The author acknowledges this saying “investing, after all, is not an exact science. Few stocks ... are picture perfect in every single respect.”

These ambiguous signals make it difficult to evaluate the trading system. For example, suppose I buy a stock that then tanks. My tendency would then be to focus in on the signals pointing to weakness and decide that I made a mistake. But the reality is that there were positive signals as well. If I always look back at the system’s signals that pointed in the correct direction and ignore the ones that got it wrong, then I will tend to blame myself for poor trades instead of blaming the system.

So, after reading the entire book and attempting to apply all the rules to real stock charts, I’m left with no evidence one way or the other whether CAN SLIM works or not. So, I decided to follow Larry Swedroe’s lead and look at CAN SLIM Select Growth Fund (CANGX) which was launched in 2005.

If the CAN SLIM system has any value for new investors, presumably CAN SLIM experts can make it work. According to Yahoo Finance, CANGX is a mid-cap growth stock. From 2005 Oct. 5 to 2013 July 19, the MCSI mid-cap growth index grew by 84%. During the same period, CANGX grew by only 53%. On average, CANGX trailed its benchmark by 2.3% per year.

If CANGX is run by CAN SLIM experts who can’t beat their index, what hope do new investors have? Galgani says “you do not have to be at the mercy of the market. You can see the right time to get in—and out.” However, the evidence suggests that CAN SLIM can’t help you to do this. The author derides “buy and hold investing,” but CANGX lost to a buy and hold strategy.

Despite giving this book a fair shake, in the end I find it to be mostly an extended ad for Investor’s Business Daily. The book offers advice steering new investors to a strategy filled with uncompensated risk.

10 comments:

  1. Rats. I thought this was going to be an article on how to sell my surplus plants (aka Matthiolas) and make a killing. Frankly, I'd likely have more luck with that than with trying to buy and sell based on chart analysis.

    The book I want to read isn't out yet. If you see the BBC be sure to tell him he has an audience waiting!

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    1. @Bet Crooks: I have surplus plants, too. If I stop calling them weeds, do you think people will buy them?

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    2. I'm pretty sure if you advertised as "'Weed' for sale. 100% organic" you'd get a few calls.... ; )

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  2. I suppose "buy and hold and don't trade stocks if ever" wouldn't sell many copies would it?

    For the most part, I wait to buy stocks when the price tanks, or at least, approaches the 52-week low. That's a signal for me. Funny that he says: “if a stock drops 7% to 8% below what you paid for it, sell.” I normally do the opposite. My most recent example, Telus.

    BTW - unrelated topic, Thinking Fast and Slow by Kahneman is amazing read.

    Mark

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    1. @Mark: I guess it depends on the reason for the 52-week low. For good companies you get a great buying opportunity. For a company like Eastman Kodak, it was a death spiral.

      I'm glad you're enjoying Kahneman's book as much as I did.

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  3. I read a similar book by William J O'Neil, founder of Investors Business Daily a long time ago. Pretty much the same title, too. I used CANSLIM for awhile and had pretty good success, but that was during the late 90s when momentum was pretty much the only thing that was required to succeed in the market. Luckily my success scared me just when the bubble was poised to pop, and I moved a lot of my portfolio to Berkshire Hathaway around 99/2000.

    I recently sold a major holding and I'm looking for something to allocate the proceeds to. Seems like ETF index funds are a wise choice, considering how hard it is to beat the market and how easy it is to virtually match it. Do you have a post on what specific ETFs you use? I currently have small positions in XIC and VFV.

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    1. @Gene: I've been reluctant to disclose my portfolio mix, mainly because I wouldn't want anyone to follow it blindly. That said, core holdings of mine are XIU in Canada and VTI in the US. I'm also still holding some Berkshire Hathaway (my last individual stock).

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  4. Have you considered making a pseudo index fund by buying perhaps 15 large-cap stocks from each of Canada and the USA, that would mimic an index? Not ideal for a growing portfolio, but for a relatively-stable account, and low commissions, it could save money on fees. Drawbacks are that it would be harder to increase or decrease holdings, and the savings wouldn't be huge over already inexpensive ETFs.

    I was intrigued by this article: http://www.theglobeandmail.com/globe-investor/investment-ideas/got-two-minutes-you-can-beat-the-market/article7243076/?page=all

    I've also considered subscribing to a value-oriented newsletter, but it's hard to assess whether it would result in better performance than an index or what I could do on my own.

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    1. @Gene: I have considered trying to build my own index, but I concluded that I don't have an expectation of coming out ahead. But, I don't think I've written about this before. Maybe next week.

      The two-minute portfolio is a two-stock strategy. That makes it so high-risk that you expect high deviation from the index. If you go through a couple dozen such strategies, one is bound to outperform nicely over 2 or 3 decades. But most will underperform.

      Subscribing to newsletters isn't my thing any more. I find them to be full of manufactured overconfidence.

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    2. Actually, it's a 20-stock portfolio, two large-cap companies from 10 different sectors. Not sure if I'll implement it, but I would likely do so for the Canadian and US market if I did. Forty stocks would offer pretty good diversification. Would maybe add another ten stocks from different screens to come up with a 50-stock portfolio... now it's getting to be almost too many holdings. Anyway, something I'll have to decide upon.

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