Bob Farrell’s 10 investing rules
This never gets old and every few years I like to dust this off and post it on the blog. I have a shortcut on my computer to this article on Marketwatch.com and click on it every now and then when I need a reminder. Uncanny, how just a few months after this originally posted on Marketwatch the market imploded.
Bob Farrell was a pioneering technical analyst that worked with Merrill Lynch as far back as the 1950′s, so he saw it all. He came up with his 10 rules for investing, which have proven time and time again to be correct. From the Marketwatch.com article by Jonathan Burton on June 8th, 2008:
1. Markets tend to return to the mean over time
By “return to the mean,” Farrell means that when stocks go too far in one direction, they come back. If that sounds elementary, then remember that both euphoric and pessimistic markets can cloud people’s heads.
2. Excesses in one direction will lead to an opposite excess in the other direction
Think of the market as a constant dieter who struggles to stay within a desired weight range but can’t always hit the mark.
3. There are no new eras — excesses are never permanent
This harkens to the first two rules. Many investors try to find the latest hot sector, and soon a fever builds that “this time it’s different.” Of course, it never really is. When that sector cools, individual shareholders are usually among the last to know and are forced to sell at lower prices.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
This is Farrell’s way of saying that a popular sector can stay hot for a long while, but will fall hard when a correction comes. Chinese stocks not long ago were market darlings posting parabolic gains, but investors who came late to this party have been sorry.
5. The public buys the most at the top and the least at the bottom
Sure, and if they didn’t, contrarian-minded investors would have nothing to crow about. Accordingly, many market technicians use sentiment indicators to gauge investor pessimism or optimism, then recommend that investors head in the opposite direction.
6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold.
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
Markets and individual sectors can move in powerful waves that take all boats up or down in their wake. There’s strength in numbers, and such broad momentum is hard to stop, Farrell observes. In these conditions you either lead, follow or get out of the way.
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
9. When all the experts and forecasts agree — something else is going to happen
As Stovall, the S&P investment strategist, puts it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.
10. Bull markets are more fun than bear markets
No kidding.