Bob Farrell’s 10 investment rules to deal with market uncertainties

Apr 06, 2024, 12:03:36 PM IST1/12

How do stock prices get influenced

Famed market Guru Bob 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.

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10 rules for better investment returns

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.

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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.

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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.

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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.

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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, once that trend ends, the correction tends to be sharper.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.

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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 the market, as investors who think independently tend to outperform the herd mentality.

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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.

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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 blue chip names to lead the way.

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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

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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.

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Bull 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.
(Disclaimer: This slideshow is based on various speeches of Bob Farrell, whose videos are available on YouTube)

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