Wall Street veteran Bob Farrell was the chief stock market analyst and senior investment advisor at, where he worked for over 45 years after finishing his masters at.
Although Farrell retired long back, his years of wisdom summarized in his famous book, titled 10 Market Rules to Remember, has lived on and is always referred to when investors get into difficult market situations.
Farrell is one of the pioneers of technical securities analysis, who always endorses the use of the sentiment gauge to better evaluate and understand how a market andmight move.
Farrell believes stock prices are influenced not only by the company’s financial strength or business line, but also by the strong patterns depicted by the stock’s trading history.
Farrell said being aware of the investor sentiment can help avoid selling near the bottom and buying near the top, which often goes against an investor’s instincts.
“Human nature causes individual investors and traders to often feel most confident at the top of a market. At the same time, they feel most pessimistic or cautious at market bottoms. Awareness of these emotions and their potential consequences is the first step towards conquering adverse effects,’ Farrell said in an interview whose video is now available on..
Let’s take a look at the 10 market rules that Farrell developed, which he recommends to all investors to be able to achieve better investment returns.
Markets tend to return to the mean over time
Farrell says sometimes the market trends get overextended in one direction or another due to extreme optimism or pessimism, but the prices eventually return to their long-term average.
However, he cautions investors to be careful as euphoria and pessimism can cloud their judgement and it is easy to get swayed and lose perspective amid huge market swings.
“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,’ he says. So, Farrell advises investors to stick to a plan and not let any external factor — like daily gossip and commotion of the market — cloud one’s judgement.
Excesses in one direction will lead to opposite excess in the other direction
Farrell says investors can expect overcorrection when market overshoots, as when it does it on the upside, it tends to overshoot on the downside also like a pendulum. The further it swings on one side, the further it rebounds to the other side.
“Think of the market baseline as an attached 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,” he says.
He says during a market crash, investors get a great opportunity to buy stocks at attractive prices, but these tend to overcorrect in either direction. Farrell advises investors to be cautious of this and deal with such situations with patience and take careful action to protect capital.
There are no new eras — excesses are never permanent
Farrell says there are a group of hot stocks every few years that do exceptionally well, but they eventually overheat and their prices revert to mean.
Farrell says nothing lasts forever, especially in the financial world. But investors tend to believe when things are going in their favour, they can earn limitless profits. There have been many speculative bubbles involving various stock groups over the last 100 years and over-optimistic investors always felt that they would sustain their extraordinary performance. But this doesn’t happen and markets do revert to the mean, he says.
“There is nothing new on Wall Street. There can’t be, because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again,” he says quoting Jesse Livermore.
Market corrections don’t go sideways
Farrell says a market that moves sharply tends to correct sharply too. He feels even though a strong trend can extend for a long time, but once that trend ends, the correction tends to be sharper.
“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 ,’ he says.
Farrell advises investors to be careful while trading in fast-moving markets, and recommends the use of stop losses to avoid emotional responses. According to Farrell, stop orders can help traders to limit losses, or lock in profits when prices swing in either direction.
The public buys the most at the top and least at the bottom
Farrell says the average individual investor is most bullish at market tops and most bearish at market bottoms. But in order to achieve extraordinary success in investing, one needs to follow a contrarian approach to market, as investors who think independently tend to outperform the.
He says contrarian-minded investors can make good money if they follow the sentiment indicators and can get their timings right.
Fear and greed are stronger than long-term resolve
Basic human emotions like greed and fear are perhaps the greatest enemies of successful investing, says Farrell. He says these can act quickly and influence a trading decision in the wrong direction.
So he advises investors to have a disciplined trading approach with a specific day-to-day plan to generate returns successfully. He advises investors to maintain calm, not panic and act with courage when fear stalks or when greed rules the market, as it is better to stay patient than to let emotions rule.
“Don’t let emotions cloud your decisions or affect your long-term plan. Plan your trade and trade your plan. Prepare for different scenarios so you are not taken by surprise with sharp adverse price movement occurs. Sharp declines and losses can increase the fear factor and lead to panic decisions in the heat of the battle. Similarly, sharp advances and outsized gains can lead to overconfidence and deviations from the long-term plan,” says he.
Markets are strong when broad, weak when narrow
Markets are at their strongest when they are broad, but weakest when they narrow to a select few blue-chip names. Farrell says since a narrow rally indicates limited participation, the chances of failure are above average, as markets cannot continue to be dependent on a few
names to lead the way.
He says when smallcaps and midcaps contribute to a rally, it indicates much more strength and increases the chances of further gains.
Bear markets have three stages
Farrell says a bear market has three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend. A typical bear market pattern often involves a sharp selloff after which there is what’s called a sucker’s rally or an oversold bounce that retraces a portion of that decline.
This reflexive rebound draws investors into the market as prices jump quickly before they come crashing down again. He feels these rallies are the result of speculation and hype and do not last long but cause investors a lot of damage, as they may buy on temporary highs and end up losing money when asset prices drop. The decline then continues at a slower and more grinding pace to levels where fundamentals deteriorate and valuations become more reasonable and a general state of depression sets in.
Farrell says in a bear market, prices te
nd to drop 20% or more and mostly involve all the indices, which is generally caused by weak or slowing economic activity.
Be mindful of experts and forecasts
When all the experts are in agreement about something, usually the opposite happens. Farrell is of the view that when all the experts and forecasts predict excessive bullish sentiment, it should be viewed as a warning sign.
Investors should consider buying when stocks are not attractive and news flow about it is all bad. Conversely, one should look to sell when stocks are on everybody’s radar and the news flow is very good, as such a contrarian investment strategy usually delivers great rewards to patient investors.
“Going against the herd can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when the sentiment is darkest,” says he.
markets are more fun than bear markets
Most investors enjoy the bull market as the prices continue to rise during these periods and there is general optimism all around. Only short sellers do not enjoy a bull market, as they sell borrowed securities expecting the prices to drop to be able to return an equal amount of shares in the future.
“Wall Street and Main Street are much more in tune with bull markets than bear markets,’ he says.
It’s easy to get swayed by the swings of emotions and daily market news, but if one follows these time-tested market rules that can lead to success, as these rules can help look beyond the market chatter and ride a range of emotions that always tend to affect investment choices.
(Disclaimer: This article is based on various speeches of Bob Farrell, whose videos are available on YouTube)