This review is based on our experience using MarketSmith and is merely our opinion. It is not meant to be a final judgment but should provide you with valuable insight if you’re considering whether or not to pay for the service. We’ll start with an overview of the platform, dive into our test results and then share our final thoughts.

Training Materials

Once you’ve paid your subscription fee, Investor’s Business Daily (IBD) sends out a wealth of information to help you start. It can be overwhelming at first if you’re not familiar with chart patterns or William O’Neil’s book, How to Make Money in Stocks. The easiest way to get started is by focusing on the 85 page Mastering the Markets booklet. The booklet is broken down into two sections, Using MarketSmith and Applying MarketSmith.

The using MarketSmith section covers an overview of charts, the software’s list panel, stock and fund screeners and support resources. The applying section consists of four chapters; Identifying Winning Stocks, Time the Market, Buy Right – Sell Right, Develop Routine and Evaluate Sponsorship Industry Groups. Links to Webinars and Case Studies provide further education opportunities. Quarterly stock guides offer a deeper dive into stock analysis and how to be successful using the service. We found the platform easy to use, including the mobile application. The online video tutorials, coupled with the education and FAQ materials, answered most questions that arose. Support was always there to help.

Stock Ideas

One of the most significant benefits of using MarketSmith is time saved. Subscribers gain access to curated stock lists and automated chart pattern recognition. Curated growth stock lists include the Growth 250, IBD 50, Top-rated IPO’s, Stocks breaking out today and Stocks Near Pivot Points.

You can also create stock screens or copy stock screens provided by MarketSmith coaches in the quarterly stock guides. While there may be better stock screeners on the market for the money, they don’t include Investors Business Daily proprietary ratings.

The service enables you to set up alerts to get notified when stocks from the curated list approach ideal buying points. The buying points include breaking out, near pivot points, in tight price action areas or if the stock has advanced 20% more in price from its pivot point within 15 days. These are excellent starting points to help you identify possible trading opportunities.

Pattern Recognition

To become a successful stock trader, you must be able to identify optimal buy and sell points. This is where stock chart patterns come into play.  Identifying stock chart patterns takes a lot of time and energy. MarketSmith automatically identifies chart patterns and highlights them using their pattern recognition technology, a huge time saver. Highlighted stock patterns include flat base, IPO base, Cup with Handle Base, Saucer with Handle Base, Double Bottom Base, Consolidation, Cup Base and Ascending Base.

Test Results

We started our test by paper trading 200 stocks at their proper buy points based on the stock alerts we received from MarketSmith. The main goal was to see if stocks identified as being near ideal buying points with good chart patterns would provide a defined edge over market averages and help us automate trading. Keep in mind that this is not a historical study; it’s a snapshot in time. That said, our test was done during a bull market, which should favor momentum stocks breaking out.

Over one month, the 200 stocks in aggregate outperformed the S&P 500 by 0.75%. Over three months, they topped the S&P 500 by 0.31% on average. Contrary to what we initially expected to find, holding all stocks for 12 months provided the best performance, outperforming the S&P 500 by 4.13%.

While this looks good at first glance, there are a few significant problems in replicating the results in a real-world brokerage account.

  • We did not take the bid/ask spread into consideration. This would have had a negative impact on results.
  • In order to buy stocks, you need to have cash on hand. Therefore, traders can’t be 100% invested in stocks at all times. The cash holdings would be a huge drag on performance and weren’t considered when comparing the returns to the S&P 500.
  • We did not subtract capital gains taxes, which would be a further drag on performance.

Applying Buy and Sell Rules

Additional surprises popped up during our test analysis. In the MarketSmith materials provided and the book, “How to Make Money in Stocks,” IBD founder William O’Neil advises cutting all stock losses at 7-8% to protect against catastrophic losses. Although this sell rule did protect against significant losses in individual stocks, the sell rule did not improve performance. It hindered results during this trial as many stocks quickly recovered and went on to higher gains.

IBD materials suggest that you take profits when a stock has gained 20-25% from your buy point because most growth stocks rise 20-30% before building a new base. Additionally, taking profits allows you to free up capital to buy other stocks at proper buy points that should have higher price appreciation potential in the short-term. An exception to this is power to the pivot stocks. These are stocks that have advanced 20% more in price from their pivot points within 15 days. You want to let these stocks run longer before taking profits. Again, we found this rule would have hindered performance during this test period.

Our study was rigid and short-term. It eliminated human decision making. Our goal was to see if we gain an edge only using MarketSmith’s automated alerts. If you’re not starting with an edge that beats the market, it’s challenging to override the rules using human judgment to gain an advantage.

Chart Pattern Studies

Market conditions can have a significant impact on the success of technical indicators and chart patterns. Some chart patterns perform exceptionally well during bull markets but struggle during consolidation periods and bear markets. During consolidation periods and bear markets, false breakouts are common. This can lead to death by a thousand cuts as continued small losses, and short-term reversals turn into one large loss.

The CFA institute has the following to say in their study materials, “The AMH and evolutionary theories of markets predict that some investment techniques will work at times and be ineffective at other times as traders adapt to their current environment. This conclusion is supported by research that finds technical analysis is effective at times and in some markets and ineffective at other times. Early tests using these techniques are demonstrating that many widely used technical indicators do not generate profits on their own.”

David Aronson, the author of Evidence-Based Technical Analysis, tested the performance of 6,402 technical rules; none outperformed the S&P 500 over time. Some academic research has shown that chart patterns and technical indicators can beat the market but only offer only marginal incremental returns that would not survive transactions costs.

If you’re interested in an excellent overview of chart patterns, we recommend the Encyclopedia of Chart Patterns by Thomas Bulkowski. He has tested common chart patterns and provides rankings. Dig around his website, and you’ll find chart pattern results for 1-3 months, during bull markets and bear markets.

As common chart patterns have become well known, they have lost much of their edge. That’s one reason you won’t find Renaissance Technologies, quant shops, or hedge funds sharing their methods with the public. It takes a lot of hard work to gain an edge in the market and those edges are continually evolving. The last thing you want to do is give it away.

William O’Neil Fund Performance

William O’Neil himself has struggled using his strategies to help manage public funds. His first attempt started as a tremendous success during the bull market of 1966-’67. The fund then lost 53.6% in the ensuing bear market from 1969-74, compared with an 18.8% loss for the S&P 500. The large drawdown caused the fund to fold. This is a recurring theme of many chart pattern traders. Most of the great success stories you hear about occur during brief periods in raging bull markets. The subsequent consolidation periods and bear markets lead to large losses.

O’Neil’s second attempt at managing public money came in 1992. This time he picked David Ryan, one of his most successful protégé’s to run his New USA Growth Fund. David Ryan won the U.S. Investing Championship stock-picking contest in 1985, 1986, and 1987. This fund also closed. According to Barron’s, the fund had a total return of 3 percent from April 1992 through June 1994, versus 17.4 percent for the S&P 500.

Next, William O’Neil launched the CAN SLIM Select Growth Fund (CANGX) in late 2005. The fund produced a total loss of just over 7% from January 2006 through June 2010.

O’Neil and company are hoping the fourth time is a charm. O’Neil Global Advisors launched three new funds in February 2020 based on their proprietary quantitative factor research. The funds include “ Chameleon, a classic market timing strategy, Raven, a long-short U.S. equity growth strategy, and Timberwolf, an alternative risk premia strategy that uses proprietary quantitative factors.”

Final Thoughts

Positives

  • Curated stock lists save time.
  • The only stock screening platform with IBD proprietary data available.
  • Pattern Recognition and breakout alerts save time for investors.
  • It can work well incredibly well in a bull market, especially during the early stages and final blow out phases.

Negatives

  • Test results by independent researchers show common chart patterns fail to beat market averages in aggregate. They are now well known and thus have lost their edge. Our results showed a modest beat over 12 months during a bull market.
  • MarketSmith Cost $1,500 at the time we subscribed. That equates to a 1.5% fee on a $100,000 account.
  • William O’Neil has started three mutual funds based on his methodologies. All eventually lagged the stock market averages by a wide margin and were closed. Will the fourth time be a charm?

William O’Neil’s stock selection process is based on replicating the stock market’s biggest historical winners’ characteristics. On the surface, that sounds like a good idea. This approach’s problem is that it doesn’t consider all the losing stocks that shared the same attributes as the winning stocks.

If you plug O’Neil’s base financial criteria for the biggest stock winners into a stock screener, it’s highly improbable you’ll beat stock market indices. As for chart patterns, IBD doesn’t prove that chart patterns can beat the market on their own. MarketSmith provides a time-saving service for serious traders. It takes dedication and talent to beat the market.