How To Use Breakdowns In The O’Neil Methodology
At O’Neil Global Advisors, in addition to fundamental research on companies, a key part of our idea analysis process is examining those that are making new highs and, in turn, breaking below key support levels.
Regarding breakouts, we talked about the need for the count to increase significantly in order to gain confidence in a sustained uptrend in stock markets (see February 2023 article). Since August 2022, there have been several short-term spikes in breakout totals. Nonetheless, past cycles have seen a larger rise to give the market the all clear signal. For example, the weekly total rose to over 300 breakouts in July 2016, about five months after recent market lows, and then continued to do so consistently throughout 2017. In June 2019, about six months after the market bottoms, the total rose to over 300. and resulted in a very strong market for the next 6-8 months. In August 2020, five months after the lows, the total rose to 260, leading to another 15+ months of upside in the market.
As seen above, breakout totals last increased to nearly 200 for two weeks in February 2023, but fell short of a major surge. Now let’s take a look at how these breakouts traded or failed.
First, a brief description of a successful versus failed breakout and the reasons for monitoring each.
- Breakout and close above price pivot or previous high to the left of a defined base/or consolidation period.
- Keeps climbing and immediately starts a new uptrend or sustains a minor pullback of less than 7% before finding support and then continues higher.
- A recent example is Duolingo, Inc. (DUOL):
- Over the long term, an ideal sequence is a breakout, followed by a rally (20% or more), followed by the formation of a new base on the previous base. We would typically suggest taking some profits on stocks that are up ~20% from the pivot and waiting for a new base to form.
- A recent example is First SolarFSLR, Inc. (FSLR), see below:
- A break above the pivot, failing to rally or possibly rallying but <20%, reversing from below backwards within the old base and trading -7% to -10% or more below the pivot price (a tighter O'Neil cutoff would actually be between -5% and -7% This “stop-loss” resiliency is an important tenet of O'Neil's strategy, but depends on buying “right.” For example, if For example, buying a stock 10% above the pivot price and then dropping back 10% to the pivot would trigger the stop loss even though the breakout is still intact, so it's not ideal to extend stocks past a few percentage points to buy above the pivot.
- A recent example of a breakdown is Morgan StanleyMS (MS), see below:
There is also a third category where the outbreak is pending. This would happen when a stock breaks out but makes no progress and retraces to its old base but is not trading between -7% and -10% or more below the pivot. A recent example below is Rockwell AutomationROK, Inc. (ROK):
A review of US market breakouts since early 2023 shows that 650 stocks over $500 million have broken out of their base at some point. Of these, the chart below breaks down their current positioning relative to their pivot price.
Unfortunately, the results have turned negative in recent weeks.
- A clear majority, 71% of stock breakouts are currently back below their pivot.
- About 43% have clearly failed and are at least -10% or more below the pivot.
- At best, only 12% are at least +10% above their pivot. Another 18% is above the pivot, but by less than +10%.
- The remaining (28%) are either just below pivot or fluctuate between -5 and -10% below it on failure.
Below are a handful of recent breakouts that are either about to fail or have already failed.
In summary, understanding and respecting a failed breakout is a key component of the O’Neil methodology. In particular, we believe that executing a stop loss on stocks that have breached their breakout point is essential to generating strong returns over time. Unfortunately, in terms of the broader stock market, the recent trend of failing breakouts suggests that stocks are yet to get the all-clear. As a result, investors should remain cautious until the overall technical picture improves.
Kenley Scott, Director, Global Sector Strategist at William O’Neil + Company, a subsidiary of O’Neil Global Advisors, was a key contributor to the data compilation, analysis and writing of this article.
follow me Twitter.
No part of the author’s remuneration was, is or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates and/or their respective officers, directors or employees may have an interest or be long or short and may at any time make or sell purchases or sales as principal or agent in the securities referred to herein.
O’Neil Global Advisors, Inc. (OGA) is an SEC-registered investment advisor. Information on investments in companies managed by UCIs is not available to the public. Under no circumstances should the information contained in this report be construed as an offer to sell or a solicitation of an offer to buy any securities or other investments. Nothing contained herein constitutes a recommendation to buy or sell any investment vehicle or other property, or to enter into any transaction or to enter into any legal act of any kind in any jurisdiction in which such offer or recommendation would be unlawful. Past performance of any investment strategy discussed in this report should not be taken as an indication or guarantee of future performance. Nothing contained herein constitutes financial, legal, tax or other advice, nor should any investment or other decisions be made solely on the basis of the information contained herein. © 2023, O’Neil Global Advisors Inc. All rights reserved. No part of this material may be copied or reproduced or redistributed in any form without the prior written consent of OGA.