CANSLIM(R) - Part 1

I am an avid follower of the CANSLIM investment methodology. In a nutshell this strategy uses a blend of fundamental and technical analysis to identify the strongest stocks in the strongest groups at crucial market turning points. CANSLIM has uncovered such monster stocks as Cisco, Apple, Hansen and Research in Motion which made the investment careers of those who bought at the right time. For every one Apple we may have 100 ho-hum stocks which yield of mixture of winners and losers while we wait for that one special stock o appear. What to do in the meantime?

CANSLIM is a great way to search for those shooting stars, but let’s be honest people who bought Apple or RIMM or Cisco when they first broke out had no idea how far these stocks might go. They may have had the attributes of past winners, as many other stocks at the time did, but there was no sure fire way to quantify how far the stocks might rise. For every Apple I am sure that there are 100 other similar stocks that either modestly grew or just fizzled. We can use fancy computer screens and advanced charting software to aid in our selection but when you boil it down buying stocks is a gamble.

When I first started to invest I really focused on finding that one great stock that would make me. I followed the CANSLIM tenants to cut all losses short when a purchase declined 7-8% from my buy point and I concentrated my holdings in 4 to 5 stocks. I would let my winners run and cut my losers short. I had no real money management or position sizing strategy which Van Tharp defines as “how much”. I was really more of a steady state investor. I divided my capital into fifths and would purchase stock in those amounts. I soon ran into an interesting problem.

In a down or struggling market this steady state method would chip away at my capital if I hit a losing streak. For instance if I had $10,000 and bought one stock that showed a 20% profit or $2,000 it was possible to have 3 or 4 losers in a row that could wipe out my gain. So if I purchased a 3 more stocks for $10,000 each and cut my losses short at 7% I would have lost $2,100. This is actually pretty easy to do in a weak or struggling market like we have now. I thought there must be a better way to do things instead of just getting pounded while waiting for market distribution days to pile up.

In Part 2 of this series I will discuss how I came upon the money management algorithm which I use today and why I credit it for my survival in this year’s market.