Bob Farrell is a Wall Street veteran who has experienced bull and bear markets since the 1950s.
In a recent interview, he reminds us that stock prices are not immune to either the forces of gravity or the fists of the Federal Reserve. The longer a trend persists, the more people look at the trend as permanent. That’s why investors buy the most of an asset, like stocks or bonds, at the peak in prices, and the least at the troughs.
His well-crafted market rules mentioned below are excellent guidelines.
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Markets tend to return to the mean over time. Price trends get overextended in one direction or another, but eventually return (revert) to their long-term average. In other words, extreme volatility is generally temporary. So you must not get swayed by price swings.
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Excesses in one direction will lead to an opposite excess in the other direction. Think of a pendulum. The further it swings to one side, the further it rebounds to the other side. So don’t get carried away.
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There are no new eras – excesses are never permanent. Fads will come and go. New narratives. New hot funds and stocks. Speculative bubbles. It is history repeating itself. Don’t get played. As Jesse Livermore puts it: A lesson I learned early is that there is nothing new in 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.
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Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. A trend can extend for a long time. The bubble may keep rising beyond what anyone thinks possible. The correction that follows can be brutal and much more harsher than what anyone thought possible.
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The public buys the most at the top and the least at the bottom. The retail investor succumbs to emotions. Is greedy during bull runs and buys heavily at the top. And is fearful when it falls and sells in panic.
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Fear and greed are stronger than long-term resolve. Do not underestimate the power of emotions. That is why disciplined investing helps. Have a buy thesis in place. Invest in funds via systematic investment plans.
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Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. A market rally won’t last for long when it is just a few large-caps that are pulling up the big indices. The breadth of the rally is important. Are mid and small and micro caps also rallying?
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Bear markets have three stages – sharp down, reflexive rebound, and a drawn-out fundamental downtrend. The decline will start at the peak but there will be much more pain to follow.
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When all the experts and forecasts agree – something else is going to happen. Contrarian investors, pay heed.
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Bull markets are more fun than bear markets. In a bull market everyone thinks they are smart. And the value of their portfolio rises feeding into the exuberance. Conversely, no one likes to see the value of their portfolio drop.
To delve more on the subject in current times, DSP Mutual Fund gives it a practical application in charts.