10 Timeless Investing Rules From Wall Street Legend Bob Farrell

10 Timeless Investing Rules From Wall Street Legend Bob Farrell

It’s always helpful, and a good practice, to review investing and trading rules that guided the very best.  And Wall Street legend Bob Farrell of Merrill Lynch fame is certainly one of the very best of all-time.

How about a guy who was pioneering in his use of technical analysis AND investor sentiment figures – as far back as the late 1950s?

In Bob’s time, he’s seen it all – bull markets, bear markets, and sideways markets.  Here are Bob Farrell’s famous Ten Market Rules to Remember, courtesy of Marketwatch (my commentary below each bolded rule):

1. Markets tend to return to the mean over time

And not only do markets usually regress to the mean, but the often overshoot the mean in the opposite direction.  Hence a return to “fair value” in asset prices (be it stocks, housing, or tulips) does not necessarily mean it’s a good time to buy.

2. Excesses in one direction will lead to an opposite excess in the other direction

Commodity prices, supply, and demand often illustrate this beautifully.  Low prices lead to producers reducing their output.  This commonly over corrects over time – leading to excessive production, a boom in prices, and of course, an ensuing bust – and we start the cycle all over again.

3. There are no new eras — excesses are never permanent

But I thought it was different this time?

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways

Gold in 1980, the NASDAQ in 2000, and Crude Oil in 2008 are all great examples of this.

5. The public buys the most at the top and the least at the bottom

They love ’em at the highs, and hate ’em near the lows.

6. Fear and greed are stronger than long-term resolve

I probably wouldn’t have appreciated this one without getting clobbered in the 2008 across-the-board crash.  Suddenly, the reach for an extra couple of percentage points in the previous years seemed quite foolish!

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names

I think we’ve also seen this recently with markets that “peel away” from the bull run one by one.  This happened in 2007-08, when “uncorrelated” markets peeled away from the uptrend one by one, and then all crashed together.  And it looks like this phenomenon may be taking place again – with US stocks as the last holdout of the reflation rally down getting taken to the woodshed.

8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend

If this is the case now, you’d think we are in the third stage – the drawn-out fundamental downtrend.  But why does it feel like the ship is going down hard and fast?

I’m having a little trouble reconciling this one because I’m using the stock price action in the Great Depression as my guide.  I figure since this appears to be another depression, why not use the last one as a model.  Last time around, stock prices crashed 89% over a four year period.  If that’s a sharp down, it sure is a long one!

9. When all the experts and forecasts agree — something else is going to happen

Annual forecasts for the new year are mostly hilarious.  Remember early this year?  All the “experts” were going out on a limb and predicting 10-15% increases in stock prices.  So far, not so good on that call!

10. Bull markets are more fun than bear markets

Probably true, but us bears can derive a measure of enjoyment as we watch the excesses of the world (socialism, easy credit, and everything that comes with that) being unwould in spectacular fashion right before our eyes. 🙂

Hat tip to Tom Dyson for mentioning this list in his 12% Letter Update.