1/3/2018 Revisiting Bob Farrell's 10-Rules Of Investing | Zero Hedge

Revisiting Bob Farrell's 10-Rules Of Investing

by Tyler Durden
Tue, 01/02/2018 - 11:16

13
SHARES

Authored by Lance Roberts via RealInvestmentAdvice.com,

As I noted this past weekend, 2017 was a year for the record books. Not surprisingly, the strong advance fostered a surge in investor optimism which
pushed allocations to equities to the second highest level on record.

Day Trading: 7 Tips to Charting Trends - Capital at risk Guardian Stockbrokers

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And leveraged to boot.

Importantly, don’t mistake record margin debt levels as people borrowing against their portfolio just to make larger investment bets. In reality, they
are using leverage to support their lifestyle as well, after all, as long as stocks keep rising it’s like “free money.”  Right?

This is shown in both the level of debt used to support the standard of living and the relationship between real, inflation-adjusted, margin debt and
economic growth.

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Yes. Investors are optimistic.

The current level of exuberance, and the willingness by individuals to shun risk for the hopes of chasing wealth brought to mind Bob Farrell’s 10-
Investment Rules.
Particularly “Rule #9.” 
I have penned these previously, but these rules should be a staple for any investor who has put their hard earned “savings” at risk in the market. These
rules, which are rarely heeded in the heat of bull market, are worth revisiting as we enter into 2018.

The Illustrated 10-Rules Of Investing

1. Markets tend to return to the mean (average price) over time.
Like a rubber band that has been stretched too far – it must be relaxed in order to be stretched again. This is exactly the same for stock prices which
are anchored to their moving averages.  Trends that get overextended in one direction, or another, always return to their long-term average. Even
during a strong uptrend or strong downtrend, prices often move back (revert) to a long-term moving average. The chart below shows the S&P
500 with a 52-week simple moving average.

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The bottom chart shows the percentage deviation of the current price of the market from the 52-week moving average. During bullish trending
markets, there are regular reversions to the mean which create buying opportunities. However, what is often not stated is that in order to take
advantage of such buying opportunities profits should have been taken out of portfolios as deviations from the mean reached historical
extremes. Conversely, in bearish trending markets, such reversions from extreme deviations should be used to sell stocks, raise cash and
reduce portfolio risk rather than “panic sell” at market bottoms.

The dashed RED lines denote when the markets changed trends from positive to negative. This is the very essence of portfolio “risk” management.

2. Excesses in one direction will lead to an opposite excess in the other direction.
Markets that overshoot on the upside will also overshoot on the downside, kind of like a pendulum. The further it swings to one side, the further it
rebounds to the other side. This is the extension of Rule #1 as it applies to longer-term market cycles (cyclical markets).

While the chart above showed prices behave on a short-term basis – on a longer-term basis markets also respond to Newton’s 3rd law of motion: “For
every action, there is an equal and opposite reaction.”  
As I showed in “How Investors Are Dealt A Losing Hand:” 
Our chart of the day is a long-term view of price measures of the market. The S&P 500 is derived from Dr. Robert Shiller’s inflation adjusted price data
and is plotted on a QUARTERLY basis. From that quarterly data I have calculated:
The 12-period (3-year) Relative Strength Index (RSI),
Bollinger Bands (2 and 3 standard deviations of the 3-year average),
CAPE Ratio, and;
The percentage deviation above and below the 3-year moving average. 
The vertical RED lines denote points where all measures have aligned

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As the chart clearly shows, “prices are bound by the laws of physics.” While prices can certainly seem to defy the law of gravity in the short-term,
the subsequent reversion from extremes has repeatedly led to catastrophic losses for investors who disregard the risk. 

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

There will always be some “new thing” that elicits speculative interest.  These “new things” throughout history, like the “Siren’s Song,” has led
many investors to their demise. In fact, over the last 500 years, we have seen speculative bubbles involving everything from Tulip Bulbs to Railways,
Real Estate to Technology, Emerging Markets (5 times) to Automobiles and Commodities.

[The chart below is from my March 2008 seminar discussing that the next recessionary bear market was about to occur.]

We will likely add “Bitcoin” to this list in the not-so-distant future?

It always starts the same and ends with the utterings of “This time it is different”
As legendary investor Jesse Livermore once stated:

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“A lesson I learned early is that 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.”

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
The reality is that excesses, such as we are seeing in the market now, can indeed go much further than logic would dictate. However, these excesses,
as stated above, are never worked off simply by trading sideways. Corrections are always just as brutal as the advances were exhilarating. As the
chart below shows when the markets broke out of their directional trends – the corrections came soon thereafter.

5. The public buys the most at the top and the least at the bottom.
The average individual investor is most bullish at market tops and most bearish at market bottoms. This is due to investor’s emotional biases
of “greed” when markets are rising and “fear” when markets are falling. Logic would dictate that the best time to invest is after a massive sell-off;
unfortunately, this is exactly the opposite of what investors do.

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

As stated in Rule $5 it is emotions that cloud your decisions and affect your long-term plan.

“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.”

The chart shows the ratio of bearish funds to bullish funds as compared to the volatility index (VIX) and the ratio of bullish to bearish assets. Rarely
have such extremes previously been seen.

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In the words of Warren Buffett:

“Buy when people are fearful and sell when they are greedy.”

Currently, those “people” are getting extremely greedy.

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
Breadth is important. A rally on narrow breadth indicates limited participation and the chances of failure are above average. The market cannot
continue to rally with just a few large-caps (generals) leading the way. Small and mid-caps (troops) must also be on board to give the rally credibility.
A rally that “lifts all boats” indicates far-reaching strength and increases the chances of further gains.

The chart above shows the ARMS Index which is a volume-based indicator that determines market strength and breadth by analyzing the
relationship between advancing and declining issues and their respective volume.  It is normally used as a short-term trading measure of market
strength. However, for longer-term periods the chart shows a weekly index smoothed with a 34-week average. Spikes in the index has generally
coincided with near-term market peaks.

8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend
Bear markets often start with a sharp and swift decline. After this decline, there is an oversold bounce that retraces a portion of that decline. The
longer-term decline then continues, at a slower and more grinding pace, as the fundamentals deteriorate. Dow Theory suggests that bear markets
consist of three down legs with reflexive rebounds in between.

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The chart above shows the stages of the last two primary cyclical bear markets. The point to be made is there were plenty of opportunities to sell
into counter-trend rallies during the decline and reduce risk exposure. Unfortunately, the media/Wall Street was telling investors to just “hold
on” until hey finally sold out at the bottom.

9. When all the experts and forecasts agree – something else is going to happen.
This rule fits within Bob Farrell’s contrarian nature. As Sam Stovall, the investment strategist for Standard & Poor’s once stated:

“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

As a contrarian investor, and along with several of the points already made within Farrell’s rule set, excesses are built by everyone being on
the same side of the trade. Ultimately, when the shift in sentiment occurs – the reversion is exacerbated by the stampede going in the opposite
direction

Currently, everyone on Wall Street is optimistic 2018 will turn in another positive year making it the longest streak in history of positive return years
for the market.

Being a contrarian can be quite difficult at times as bullishness abounds. However, it is also the secret to limiting losses and achieving long-term
investment success. As Howard Marks once stated:

“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies
and the pain imposed by being out of step, since momentum invariably makes pro-cyclical actions look correct for a while. (That’s why
it’s essential to remember that ‘being too far ahead of your time is indistinguishable from being wrong.’)
Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves
against you – it’s challenging to be a lonely contrarian.”

10. Bull markets are more fun than bear markets

As stated above in Rule #5 – investors are primarily driven by emotions. As the overall markets rise; up to 90% of any individual stock’s price
movement is dictated by the overall direction of the market hence the saying “a rising tide lifts all boats.”

Psychologically, as the markets rise, investors begin to believe that they are “smart” because their portfolio is going up. In reality, it is primarily
more a function of “luck” rather than “intelligence” that is driving their portfolio.
Investors behave much the same way as individuals who addicted to gambling. When they are winning they believe that their success is based on their
skill. However, when they began to lose, they keep gambling thinking the next “hand” will be the one that gets them back on track. Eventually
– they leave the table broke.

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It is true that bull markets are more fun than bear markets. Bull markets elicit euphoria and feelings of psychological superiority. Bear markets
bring fear, panic, and depression.
What is interesting is that no matter how many times we continually repeat these “cycles” – as emotional human beings we always “hope” that
somehow this “time will be different.” Unfortunately, it never is and this time won’t be either. The only questions are: when will the next bear market
begin and will you be prepared for it?

Conclusions
Like all rules on Wall Street, Bob Farrell’s rules are not meant has hard and fast rules. There are always exceptions to every rule and while
history never repeats exactly it does often “rhyme” very closely.

Nevertheless, these rules will benefit investors by helping them to look beyond the emotions and the headlines. Being aware of sentiment can prevent
selling near the bottom and buying near the top, which often goes against our instincts.
Regardless of how many times I discuss these issues, quote successful investors, or warn of the dangers – the response from both individuals and
investment professionals is always the same.

 “I am a long-term, fundamental value, investor.  So these rules don’t really apply to me.”

No, you’re not. Yes, they do.

Individuals are long term investors only as long as the markets are rising. Despite endless warnings, repeated suggestions and outright
recommendations; getting investors to sell, take profits and manage your portfolio risks is nearly a lost cause as long as the markets are
rising. Unfortunately, by the time the fear, desperation, or panic stages are reached, it is far too late to act and I will only be able to say that I warned
you.

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Comments
This is it • Jan 2, 2018 11:21 AM
2
1 What? Will Farrell's brother isn't into acting and comedy? 

4 hedgeless_horseman  This is it • Jan 2, 2018 11:25 AM

0
 

Currently, everyone on Wall Street is optimistic 2018 will turn in another positive year making it the longest streak in
history of positive return years for the market.

Money printing.
 

7 hedgeless_horseman  hedgeless_horseman • Jan 2, 2018 11:26 AM

0
 

What is the con?  The con is that economic growth is both good and real.  It is most often neither.  The long con is
nominal returns versus real returns. 
 
What keeps the con going?  Apart from greed?  Money printing.  
 

Please, understand that if the amount of money in a closed system doubles, the value of each monetary unit halves, and
the price of everything, including stocks, increases 100%.
 
https://www.zerohedge.com/news/2017-01-13/what-can-we-learn-looking-car…

1 chubbar  hedgeless_horseman • Jan 2, 2018 12:05 PM

0
I don't see EVERYONE agreeing that stocks will go up. There are plenty of people saying that you don't buy into these valuations and
length of time it has been going up, without a lot of risk. So, I don't see how the 9th rule applies here. I do see how the FED can force
it higher, perhaps indefinitely, and if that is what the people are gambling on then I can at least understand the strategy, although I'm
not buying it.

0 The_Juggernaut  chubbar • Jan 2, 2018 12:14 PM

0
Yep.  I've never seen so many people predicting doom.  This thing still has legs (but I'm no longer buying).

0 Hugh_Jorgan  The_Juggernaut • Jan 2, 2018 6:46 PM

0
Rule #3 is a falacy-
(There are no new eras – excesses are never permanent.)

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It WAS true at one time. But, that wasn't working for globalists so it was one big thing that changed post 2008. The markets
are no longer a multitude of overlayed and interwoven organic processes. They are artificially, centrally levered by the banking
cabal and their armies of HFT algos. This means that most of the rest of the "rules" are meaningless at this point.

0 Guyzz239  This is it • Jan 2, 2018 11:34 AM

0
I though that was comedy.

NoDebt • Jan 2, 2018 11:25 AM

0
0 Bah!  It'll be fine, Rob.  You'll see.

buzzsaw99 • Jan 2, 2018 11:29 AM

1
0
11.  Always BTFD or forever be poor.

Iconoclast421 • Jan 2, 2018 11:29 AM

7
0
Markets tend to return to the mean (average price) over time
 

Hahhahahhahaha you is funny. Markets havent mean reverted for more than 6 months in the last 20+ years. 

0 Guyzz239  Iconoclast421 • Jan 2, 2018 11:36 AM

6
This is a vague and bland analysis.  I know we all love to give Shepwave traders a hard time here on ZH but at least Shepwave gives
trading signals and targets that work and make money!
See gold today.  HAH!!!!!!!!!!!!!!!!!  LIFE IS GOOD.

4 2_legs_bahhhhhd  Guyzz239 • Jan 2, 2018 12:52 PM

0
If Shepwave was worth their weight in dogshit, why are you trolling zero with your spam? Either pay for your add space which no
one will click on, or fuck off.

 
Rule #11 casino's are more honest than capital markets

0 TMac2000  2_legs_bahhhhhd • Jan 2, 2018 3:58 PM

0
.
Even a broken clock is right twice a day

2 asteroids  Iconoclast421 • Jan 2, 2018 12:45 PM

0
I believe in rule #2 with all my being. The FED can defy gravity for a period of time, but never the laws of physics.

0 Tarkus  asteroids • Jan 2, 2018 5:21 PM

0
[...] As short a time ago as February, the Ministry of Plenty had issued a promise (a 'categorical pledge' were the official words)
that there would be no reduction of the chocolate ration during 1984. Actually, as Winston was aware, the chocolate ration
was to be reduced from thirty grammes to twenty at the end of the present week.

The phrase 'our new, happy life' recurred several times. It had been a favourite of late with the Ministry of Plenty. Parsons, his
attention caught by the trumpet call, sat listening with a sort of gaping solemnity, a sort of edified boredom. He could not
follow the figures, but he was aware that they were in some way a cause for satisfaction. [...] It appeared that there had even
been demonstrations to thank Big Brother for raising the chocolate ration to twenty grammes a week. [...] Was it possible
that they could swallow that, after only twenty-four hours? Yes, they swallowed it. Parsons swallowed it easily, with the
stupidity of an animal. The eyeless creature at the other table swallowed it fanatically, passionately, with a furious desire to
track down, denounce, and vaporize anyone who should suggest that last week the ration had been thirty grammes.

The truly perverse thing is that those who orchestrate this defiance will not feel the consequences of it. And i don't mean the muppets
portrayed as being in charge. Lives will be sacrificed so that gravity may be defied in perpetuity, with diminishing returns.

“The illusion of freedom will continue as long as it's profitable to continue the illusion. At the point where the illusion becomes
too expensive to maintain, they will just take down the scenery, they will pull back the curtains, they will move the tables and
chairs out of the way and you will see the brick wall at the back of the theater.” ― Frank Zappa

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What keeps me up at night is that when the illusion will be torn down there will not be much in the way of 'life' as we recognize it now,
even after equilibrium is reached.
 

maxblockm • Jan 2, 2018 11:29 AM

0
0 Always good to review the basics.

BritBob • Jan 2, 2018 11:29 AM

0
1 The golden rule must be - never put all of your eggs in the same basket. 

Azannoth • Jan 2, 2018 11:31 AM

2
0 Yes but the simple fact of the matter is we cannot afford any serious recessions or market corrections as the economy(and society
by extension) is on knifes edge and would more likely than not just spiral out of control and drag the whole civilization with it.

They are going to continue printing "paper wealth" till the whole world is Zimbabwe

Guyzz239 • Jan 2, 2018 11:34 AM

1
2
Okay Lance we got it.  So basically you don't know where they are going.  They will go up or down.  NO TRIGGERS OR TARGETS! 
Shepwave targets and triggers get hit.  So I think they are rigged for sure. 

Non-Corporate Entity • Jan 2, 2018 11:34 AM

0
0
I feel dumber for actually taking the time to read this crap.
 
Rule 11. "You got to know when to hold 'em, know when to fold 'em...know when to walk away..."

GunnerySgtHartman • Jan 2, 2018 11:35 AM

3
0 To paraphrase Doc Brown in Back to the Future:

"Rules? Where we're going, we don't need rules."

(or so the Fed and the banksters think, anyway)

buzzsaw99 • Jan 2, 2018 11:35 AM

1
0 12. Never get involved in a land war in Asia.
13. Never go in against a Sicilian when death is on the line.

[/Vizzini]

Bondosaurus Rex • Jan 2, 2018 11:36 AM

0
0
When everyone is brave be fearful...when everyone is fearful be brave.
Buy when there is blood in the streets.
Rules to live by.

AurorusBorealus • Jan 2, 2018 11:36 AM

0
1
The new posting logic is terrible Tyler.  Now, the most mindless, quickly submitted, and pithy comments are moved far to the front. 
While anyone who takes the time necessary to think through carefully a response and comment on the article is buried at the end. 
Zerohedge has become facebook.  Shall we all be sharing emojis and funny animal pictures next?

3 buzzsaw99  AurorusBorealus • Jan 2, 2018 11:48 AM

0
sometimes the top comment is quick witted genius that cannot be topped by any means known to man.

Golden Phoenix • Jan 2, 2018 11:45 AM

0
0
I wouldn't fuck Bob Farrell with McAfee's dick.

Scipio Africanuz • Jan 2, 2018 12:06 PM

0
0 It's almost time for the generational transfer of wealth. This is as ritual as the cycles of the moon, why tell sheep they're gonna get
sheared and roasted? A little bit of studying investment history, conditions the diligent to prepare for the feast.
This time will be no different, there'll be legions of nouveau rich as well as previously wealthy, it's mother nature's way and that's OK
with me.

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Don Sunset • Jan 2, 2018 12:49 PM

0
0
What happened to Paul B. Farrell's market behavioral science analysis?

Erwin643 • Jan 2, 2018 12:58 PM

1
0
SPX and SVXY are way overbought on the monthly charts.
Still maintaining a short position (UVXY).

GassedUpOldMan • Jan 2, 2018 1:11 PM

2
0 Lamest "rules" I'ver ever heard. Only investing rules I'd ever listen to are those of the GOAT  - Benjamin Graham.

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations
not meeting these requirements are speculative."
I also prefer Soros' theory of reflexivity to analyse the market... Markets do not tend towards equilibrium, but disequilibrium.

SweetDoug • Jan 2, 2018 1:35 PM

0
0 '
'

'
Please stop posting this valuable information, as the herd might catch on!
 
OJO

V-V

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