Bob Farrell, a renowned market analyst from Merrill Lynch, shared valuable insights on market trends and technical analysis. His “10 Market Rules to Remember” are widely known and followed on Wall Street. Let’s explore these timeless principles and how they can improve investment returns.
Table of Contents
KEY TAKEAWAYS
- Investors must understand that prices always change, and corrections will happen eventually.
- Remember, things that are too much don’t last forever, and consider using stops to trade without letting emotions get in the way.
- Avoid following the crowd, and prioritize discipline over letting fear and greed control your decisions.
- Think about looking at different indexes to gauge how the market is doing.
- Be cautious when considering expert advice and forecasts.
1. Markets Return to the Mean Over Time
Whether overly optimistic or pessimistic, the market returns to more reasonable, long-term valuation levels over time. This means that returns and prices usually go back to where they started. For individual investors, the key is to create a plan and stick to it. Consider everything happening around you and make decisions based on your best judgment. Don’t be swayed by the daily noise and changes in the market.
2. Excess Leads to an Opposite Excess
Market movements can be like a car driven by an inexperienced driver, sometimes swerving too much. We can expect an overcorrection when markets go too high or too low. A correction means a big move, like more than a 10% drop from the highest price of an asset. An overcorrection means even bigger movements. There are good chances to buy assets at low prices during a market crash. But people might overreact, causing prices to swing wildly in either direction, up or down. Smart investors will be careful of this and take careful steps to protect their money with patience and knowledge.
3. Excesses Are Never Permanent
Even successful investors can fall into the trap of thinking profits will keep growing endlessly when things are going well. But in finance, nothing lasts forever. Whether buying during market lows or selling at highs to make money, remember not to count your chickens before they hatch. Eventually, you might need to act because markets tend to return to average levels, as the first two rules suggest.
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Important: Market prices tend to return to their average levels over time.
4. Market Corrections: Don’t Go Sideways
In highly volatile markets, sudden corrections can disrupt investors’ thinking ability. The key is to act decisively and use stop orders to control emotional reactions.
Stop orders Serve two purposes when asset cost activity varies. They help investors limit potential losses by creating a clear point to exit a trade, and they also allow investors to lock in profits when prices fluctuate.
5. Public Buys Most at the Top and Least at the Bottom
Many investors rely on news from their phones and market programs, often believing what they’re told. However, when the media reports a price change, it’s usually too late to act on it, and the market is already moving in the opposite direction. This is when many people make the mistake of buying at the peak or selling at the bottom.
It’s important to go against the crowd and think independently. Being a contrarian or going against popular opinion often results better than following the herd mentality.
Tip: Learn about Investopedia’s 10 Rules of Investing by getting a copy of our special print edition.
6. Fear and Greed: Stronger Than Long-Term Resolve
Emotions like fear and greed can harm your investments. Whether investing for the long term or trading daily, sticking to a disciplined strategy is crucial for success. Have a clear plan for every trade, including when to sell your stocks—when they go up and down.
Deciding when to exit a trade is harder than deciding when to enter. Theoretically, knowing when to take profits or cut losses is easy, but emotions like fear and greed can cloud your judgment when trading.
7. Markets: Strong When Broad, Weak When Narrow
While it’s helpful to focus on popular index averages, the true strength of a market’s movement depends on the overall health of the entire market. Broader averages give a better picture of the market’s strength. That’s why tracking different indexes, not just the well-known ones like the S&P 500, is beneficial.
Consider looking at indexes like the Wilshire 5000 or some of the Russell indexes to better understand the health of any market movement. The Wilshire 5000 index includes almost 4,000 U.S.-based companies traded on American exchanges, providing a comprehensive market view. Russell indexes, such as the Russell 1000 and Russell 3000, weigh companies by their market value and expose investors to the U.S. stock market.
8. Bear Markets Have Three Stages
Market analysts often notice similar patterns in both strong and weak market conditions. A typical weak market pattern starts with a big drop in prices. When a market is weak, prices often fall by at least 20%, usually affecting entire indexes. This market usually happens when the economy is struggling or slowing down.
Next comes what experts call a “sucker’s rally.” This is when prices quickly increase, attracting investors who think they can profit, but then prices drop sharply again. These rallies, driven by speculation and excitement, don’t last long. The investors who get drawn in during these rallies are often referred to as “suckers” because they buy when prices are temporarily high but end up losing money when prices fall.
The final stage of a weak market is a slow decline in prices until they reach more reasonable levels. During this time, people generally feel pessimistic about investments.
9. Be Mindful of Experts and Forecasts
It’s not magic. When everyone who wants to buy has already bought, there are no more buyers, and the market has to go down. Similarly, when everyone who wants to sell has already sold, no more sellers are left. So when market experts and predictions tell you to sell or buy, remember that everyone else is doing the same thing. Things might have already changed by the time you decide to join in.
10. Bull Markets Are More Fun Than Bear Markets
This is true for many investors because prices keep increasing during these times. Who wouldn’t like to see their profits grow? Except for short sellers. Short selling is when you sell something you don’t own. Traders who do this borrow securities and sell them, hoping the price will go down. Later, they must return the same amount of shares they borrowed.
The Bottom Line
Investing isn’t simple. There’s a lot at stake and a ton of information to absorb. Whether you’re new to trading or an experienced market watcher, it’s easy to get swept up in market news, emotions, and chaos. But if you stick to Bob Ferrell’s proven tips, you might come ahead.
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