In this study we look at William J. O’Neil’s work in Charles Schwab (SCHW) in the late 90’s.
Schwab broke out of a 12 week cup with handle pattern and went on to advance over 400%. William O’Neil bought it right at the breakout on 10/15. It then promptly did nothing for about 2 weeks, even at times showing him a loss; still, it never triggered the 8% sell rule so he held on. His patience paid off. When the stock shot up and gave him an over 20% gain inside of 3 weeks, he knew he might actually have a big winner on his hands. In fact, he would add to his position four times (10/30/98, 11/23/98, 12/14/98 and 2/23/99) on his way to a 313% gain.
From the pivot buy SCHW gave O’Neil a quick 34.2% gain. Notice what the stock did after that? It didn’t rocket higher, that’s for sure. It corrected over 16%. Yet not only was it on low volume but it found support at the 21 day moving average (something that happened a lot during its run up) and, more importantly, held above the add-on buy point of 10/30. Again, O’Neil held on and his patience (not to mention his confidence) was well rewarded. This initial pullback is something you must absolutely keep in mind. I say this because O’Neil’s Model Book studies found the average initial pullback to be about 17%.
Also, regarding SCHW’s handle (26.6% deep): normally, you want a handle to correct no more than 10-15%. However, a market coming out of a volatile bear market will often justify what ordinarily would be viewed as a “faulty” base. Charles Schwab proves this. The cup was anything but rounded or tight and the handle was, of course, much too deep. Yet that handle still exhibited extraordinary relative strength as it held well above the low of the cup, whereas the Nasdaq’s second leg down undercut the first.
The stock went on a climax run and O’Neil ended up selling it pretty much right at the top on 4/13/99 when SCHW staged an exhaustion gap. By then the stock’s P/E had risen over 100% from its first base and was 80% above its 50 day moving average; 200% above its 200 day moving average. Another Model Book statistic is this: the average Model Book stock maxes out at 51% above its 50dma; 107% above its 200dma. O’Neil’s knowledge of the market and past big winners certainly served him well.
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