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Frank Voisin
Frank Voisin
Articles (222)  | Author's Website |

Bob Farrell's 10 Mar­ket Rules to Remem­ber

May 08, 2012

Merrill Lynch’s legendary market strategist, Bob Farrell, penned the following market maxims worth a quick review (h/t The Big Picture):

1. Mar­kets tend to return to the mean over time

When stocks go too far in one direc­tion, they come back. Eupho­ria and pes­simism can cloud people’s heads. It’s easy to get caught up in the heat of the moment and lose perspective.

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

Think of the mar­ket base­line as attached to a rub­ber string. Any action too far in one direc­tion not only brings you back to the base­line, but leads to an over­shoot in the oppo­site direction.

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

What­ever the lat­est hot sec­tor is, it even­tu­ally over­heats, mean reverts, and then overshoots.

As the fever builds, a cho­rus of “this time it’s dif­fer­ent” will be heard, even if those exact words are never used. And of course, it – human nature – is never different.

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

Regard­less of how hot a sec­tor is, don’t expect a plateau to work off the excesses. Prof­its are locked in by sell­ing, and that invari­ably leads to a sig­nif­i­cant cor­rec­tion eventually.

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

That’s why contrarian-minded investors can make good money if they fol­low the sen­ti­ment indi­ca­tors and have good tim­ing. Watch Investors Intel­li­gence (mea­sur­ing the mood of more than 100 invest­ment newslet­ter writ­ers) and the Amer­i­can Asso­ci­a­tion of Indi­vid­ual Investors Survey.

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

Investors can be their own worst enemy, par­tic­u­larly when emo­tions take hold. Gains “make us exu­ber­ant; they enhance well-being and pro­mote opti­mism”, says Santa Clara Uni­ver­sity finance pro­fes­sor Meir Stat­man. His stud­ies of investor behav­ior show that “losses bring sad­ness, dis­gust, fear, regret. Fear increases the sense of risk and some react by shun­ning stocks.”

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

This is why breadth and vol­ume are so impor­tant. Think of it as strength in num­bers. Broad momen­tum is hard to stop, Far­rell observes. Watch for when momen­tum chan­nels into a small num­ber of stocks.

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 Sam 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

Espe­cially if you are long only or man­dated to be fully invested. Those with more flex­i­ble char­ters might squeak out a smile or two here and there.

What would you add to this list?

Author Disclosure: None

About the author:

Frank Voisin
Frank is an entrepreneur who owned four restaurants by the time he was twenty. He sold his businesses and returned to school, completing a concurrent Law / MBA degree. At the same time, he successfully completed all three levels of the CFA exams. He now invests full time with a focus on value investing. Frank Voisin writes about value investing topics at http://www.frankvoisin.com.

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Rating: 2.6/5 (8 votes)


The Science of Hitting
The Science of Hitting - 8 years ago    Report SPAM
Number two is a good one, only because it once again shows that the idea of efficient markets is a laughable concept that fails to incorporate human nature; I would recommend that investors listen to a speech that James Montier recently made at the CFA Institute annual conference entitled "The Fallacy of Finance" for some more detail on the disconnect between theory and reality in finance.

Thanks for the article Frank.

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