10 Timeless Rules for Investors
The investing rules of Bob Farrell have been shaped over the course of his 50-year career on Wall Street. In 1957, he joined Merrill Lynch as a technical analyst after graduating from Columbia Business School. Despite studying fundamental analysis under Gramm and Dodd, Mr. Farrell turned to technical analysis once he realized there was more to stock prices than balance sheets and income statements. His work on sentiment studies and market psychology made him a pioneer in the field. A decade of experience with dull markets, bull markets, bear markets, crashes, and bubbles led him to formulate his 10 rules for investing. Basically, Bob Farrell has witnessed it all and lived to tell the tale.
10 Timeless Rules
1. Markets Return to the Mean Over Time
No matter how extreme the optimism or pessimism, markets eventually return to a saner, long-term valuation level. This thesis predicts that prices and returns will revert to where they came from – reversion usually results in the market returning to its previous state. Therefore, the lesson for individual investors is obvious: Make a plan and follow it. Take into account all the things that are going on around you and make the best decision you can. Take your time and don’t get swept up in the daily commotion of the market.
2. An excess in one direction will lead to an opposite excess in the other.
We can expect overcorrection when markets overshoot, like a swerving car driven by an inexperienced driver. A correction is defined as a move greater than 10% of an asset’s peak price, so an overcorrection can result in bigger movements. Investors can take advantage of fantastic buying opportunities during a market crash. Overcorrections can happen in either direction – upwards or downwards – and trading can reach unbelievable heights. A well-informed investor will be aware of this, and will take the appropriate measures to protect his or her capital.
3. There are no new eras – excesses are never permanent.
It is common for even the most successful investors to believe that profits are limitless when things are going their way. In the financial world, nothing lasts forever, especially not that way. It’s always a good idea not to count your chickens before they’ve all hatched, whether you’re riding market lows to take advantage of buying opportunities, or soaring at highs to sell for a profit. The first two rules indicate that markets revert to their mean at some point, so you might have to act.
4. Market Corrections Don’t Go Sideways
The tendency for sharply moving markets to correct sharply can prevent investors from contemplating their next move in tranquility. In trading fast-moving markets, it is important to place stops on your trades to avoid emotional reactions.
When asset prices move beyond a certain point, stop orders help traders in two ways. When prices swing in either direction, they can help investors limit the amount of money they lose or lock in a profit.
5. The public buys the most at the top and the least at the bottom
It is common for investors to read the latest news on their mobile phones, to watch market programs, and to believe what they are told. When the financial press reports a price move, it is usually already over and a reversion is already underway. It is precisely at this point that John Q decides whether to buy at the top or sell at the bottom.
This rule emphasizes the need for contrarian thinking. In the long run, independent thinking always outperforms herd mentality.
6. Fear and greed are stronger than long-term resolve
An investor’s greatest enemy is perhaps their own emotions. A disciplined approach to trading is important for all traders, whether they are long-term investors or day traders. Every trade must have a trading plan. Identify exactly when it is time to sell your stock, both up and down.
It is much harder to know when to get out of a trade than to know when to get in. If you hold a security that is on a quick move, fear and greed will rapidly separate you from reality and your money when you take a profit or cut a loss.
7. Markets: Strong When Broad, Weak When Narrow
Market moves are often determined by the strength of the market as a whole, rather than the popularity of popular index averages. As a result, broader averages provide a better indication of market strength. Thus, it can be worthwhile to follow indices other than the usual suspects, such as the S&P 500.
To gain a better understanding of the health of any market move, consider watching the Wilshire 5000 index or some of the Russell indexes. Nearly 4,000 U.S.-based companies are included in the Wilshire 5000 index, and their prices are publicly available on American exchanges. An investor can also gain exposure to the U.S. stock market by investing in Russell indexes like the Russell 1000 and Russell 3000.
8. Bear Markets Have Three Stages
In both bull and bear markets, market technicians find similar patterns. According to this article, bear patterns typically involve a sharp sell-off at the beginning. Prices typically drop by 20% or more during a bear market. It is common for entire indexes to be affected by bear markets. It is generally caused by a weak or slowing economy.
This is followed by what’s known as a sucker’s rally. When prices jump rapidly before reversing sharply to the downside again, investors can be attracted to the market. Speculation and hype can result in these rallies, but they don’t last long. The question is, who are the suckers? Investors, of course. The term suckers refers to people who buy on temporary highs, but lose money when asset prices drop.
Ultimately, the bear market grinds down to levels where valuations are more reasonable and a general state of depression prevails regarding investments.
9. Be Mindful of Experts and Forecasts
No, this isn’t magic. Once everyone who wants to buy has bought, there are no more buyers. It is at this point that the market must turn downward. The same is true when all the sellers who wish to sell have sold. You should know that if everyone is telling you to sell, sell, sell-or buy, buy, buy-that there will be nothing left to buy or sell. It is likely that something else will happen by the time you jump in.
10. Bull Markets Are More Fun Than Bear Markets
During these periods, prices continue to rise, which is true for most investors. Who doesn’t enjoy seeing their profits rise? Unless you’re a short seller. Selling an asset you don’t own yourself is called a short sale. This strategy involves traders selling borrowed securities in the hope that the price will fall. As a result, the seller must return equal shares in the future.
