Wall Street legend Bob Farrell: This is how the market expert’s ten stock market rules still work today

• Bob Farrell experienced bull and bear markets, bubbles and crashes
• 45-year career at Bank of America subsidiary Merrill Lynch
• Ten market rules for successful investing

Bob Farrell’s Market Rules

Former Wall Street strategist Bob Farrell is considered a legend in the market due to his many years of experience. Back in 1957, after receiving his master’s degree from Columbia Business School, Farrell started working at Merrill Lynch as an analyst intern, paving the way for his 45-year career at the Bank of America subsidiary. He worked at the bank as chief stock market analyst for 25 years alone. Shortly before the end of his Wall Street career, the market expert, who experienced numerous bull and bear markets as well as bubbles and crashes during his time on the stock market, published his ten market rules in a note in 1998 that are intended to help investors make investment decisions. Farrell has now largely withdrawn from the public eye. His stock market tips are still relevant today.

Rule 1: Markets tend to revert to average over time

Farrell’s first rule is that stock markets always return to their moving averages after being overextended into plus or minus. “Like a rubber band that has been stretched too far – it has to be relaxed in order to be stretched again,” commented “Business Insider” on the market expert’s forecast. So, even after strong up or down trends, stock prices would return to the long-term moving average, which is called reversion. While uptrends have reversions to the mean, creating buying opportunities, bearish moves should be used to sell stocks, raise cash and ultimately reduce portfolio risk. However, panic selling should be avoided during weak market phases.

Rule 2: Excess in one direction leads to an opposite excess in the other direction

Rule number two is also based on the rule of the moving average: Similar to a pendulum, the stock market moves from one extreme to the other, as the Wall Street expert noted in the 1990s. The more the prices turn negative, the more they will return to profitability in the long term. According to Newton’s third law, it can be said: “For every action there is an equal and opposite reaction.” According to “Cash”, current examples of this are the price movements of some cryptocurrencies, especially Bitcoin. While the crypto veteran jumped to a record high of $68,789.63 in November 2021, this year it has already fallen to as much as $17,708.62.

Rule 3: There are no new eras – exaggerations never last

According to Farrell, there are always new trends in the market that push investors towards speculative investment behavior, but these are often speculative bubbles, which in the past have often led to ruin, similar to the “song of the sirens”. From the tulip mania in the 17th century to the dot-com bubble in 2000, such events have always happened. “One lesson I learned early on is that there is nothing new on Wall Street,” Business Insider quoted well-known investor Jesse Livermore as saying. “That can’t be the case, because speculation is as old as the mountains. Whatever happens on the stock market today has happened before and will happen again.”

Rule 4: Exponentially rising or falling markets usually go further than you think, but they do not correct themselves by moving sideways

Farrell’s fourth rule is that market excesses go further than investors think are logical, but they are never stopped by sideways movement. This rule is based on the expert’s second finding that extreme swings turn in the opposite direction. Corrections are always just as drastic as previous recovery rallies. According to Cash, this phenomenon can be seen in the price performance of Cathie Wood’s flagship fund ARK Innovation ETF. The ARK boss’s flagship ETF is made up of companies that are considered particularly innovative. At the beginning of the corona pandemic, the bundle of stocks with crisis winners such as Zoom, Roku and Teladoc was able to increase significantly in value, but then a countermovement set in. The price is now a long way from its highs in January 2021.

Rule 5: The public buys most at the top and least at the bottom

Farrell’s fifth rule is based on the assumption that most investors are more willing to buy when prices are high because optimism prevails at that time and they tend to be greedy. Lows, on the other hand, trigger a bad mood on the stock market and lead to fear. From a purely logical perspective, according to Wall Street legend, the right time to buy would have been when prices were low, but the fact that the majority of investors then behaved in exactly the opposite way shows how much the market is driven by emotions. “A contrarian view can pay off,” advises Bank of America analyst Stephen Suttmeier, according to Cash.

Rule 6: Fear and greed are stronger than long-term determination

The importance of emotions in the market is also demonstrated by rule number six: strong feelings such as fear and greed can dissuade investors from their long-term strategies. “Profits make us overconfident, they increase well-being and promote optimism,” said economics professor Meir Statman from Santa Clara University, according to Business Insider.

Rule 7: Markets are strongest when they are broad and weakest when limited to a handful of blue-chip stocks

According to Farrell, if as many stocks and industries as possible perform strongly, a recovery rally has the potential to last in the long term. However, if only a handful of stocks are involved, the risk is higher that the upward phase will come to an abrupt end. Therefore, not only the success of standard stocks is important, strong second-line stocks also contribute to the positive mood on the market. A recovery phase that covers a wide range of sectors could provide an indication of general growth and thus increase the likelihood of long-term profits.

Rule 8: Bear markets consist of three phases – sharp decline, knee-jerk rebound and protracted fundamental downtrend

According to Farrell, a bear market, which is characterized by persistently falling prices, is divided into three phases: First, there is a sharp decline in price in the market, before it then reacts with a countermovement and finds its way back into positive territory. Recently, however, there has been another downturn, which is now lasting for a longer period of time and is characterized by poor fundamental data. According to Suttmeier, this can currently be observed in the S&P 500, which has already fallen significantly over the course of the year, was then able to briefly catch up again, but is now in the fundamental downward phase.

Rule 9: If all experts and forecasts agree – something different will happen

Analysts’ different assessments of the market can often seem contradictory. However, every now and then it happens that the experts’ forecasts largely agree. However, according to Farrell, this is a clear sign that everything will turn out very differently than the experts expected. Business Insider cites a quote from investment strategist Sam Stovall: “If everyone is optimistic, who should buy? If everyone is pessimistic, who should sell?” The phenomenon that market experts are largely on the right track with their assessments could mean that unexpected events can further intensify the countermovement that sets in on the market.

Rule 10: Bull markets are more fun than bear markets

Farrell’s final rule may seem obvious, but it reinforces his fifth and sixth insights, which are that investors are driven by emotions. Investors think they are smart and clever when the value of their portfolio increases, but in fact it is more of a matter of luck. There are similarities to gambling here: if investors are on the winning side, they see this as justified by their skills. However, if the profits crumble, there is an assumption that the next attempt will make up for the losses. However, this strategy often does not work. The positive emotions that accompany bull markets often put investors off so that in bear markets, “everything will be completely different” during the next upswing. “Bull markets are associated with economic expansions and a positive wealth effect, while bear markets are often associated with recessions and a negative wealth effect,” Suttmeier told Cash.

So Farrell’s ten investing rules can still be applied to the market today. Not only is the market still driven by emotions, investors are also focusing on numerous new trends, which critics often see as a bubble. If the market expert is right with his findings even in the current market environment, investors can take comfort in the fact that extreme price drops will also turn into a countertrend in the long term.

Editorial team finanzen.net

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