Guest Post: Visualizing Bob Farrell's 10 Investing Rules

Tyler Durden's picture

Via Lance Roberts of Street Talk Live blog,

As the markets once again approach historic highs - the overly exuberant tone, extreme complacency and weakness in the economic data, bring to mind Bob Farrell's 10 investment rules.  These rules should be a staple for any long term successful investor.  These rules are often quoted yet rarely heeded - just as they are now.  Bob Farrell is a Wall Street veteran with over 50 years of experience in crafting his investing rules.  Farrell obtained his masters degree from Columbia Business School and started as a technical analyst at Merrill Lynch in 1957. Even though Farrell studied fundamental analysis under Gramm and Dodd, he turned to technical analysis after realizing there was more to stock prices than balance sheets and income statements. Farrell became a pioneer in sentiment studies and market psychology. His 10 rules on investing stem from personal experience with dull markets, bull markets, bear markets, crashes and bubbles. In short, Farrell has seen it all and lived to tell about it.

The 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.


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."   The first chart shows that cyclical markets reach extremes when more than 3-standard deviations above the 50-week moving average.  For the first time since the lows of the market in 2009 this has now occurred.  Notice that these excesses ARE NEVER worked off by just going sideways.


The second chart shows the price reversions of the S&P 500 on a long term basis and adjusted for inflation. Notice that when prices have historically reached extremes – the reversion in price is just as extreme. It is clear that the current reversion in the stock market is still underway from the 2000 peak.


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 investor 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.   It is always starts the same and ends with the utterings of "This time it is different"  

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


As legendary investor Jesse Livermore once stated: 

"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."

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 selloff - unfortunately this is exactly the opposite of what investors do.

The chart below shows the flow of money into equity based mutual funds.


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 composite index of bullish sentiment (an average of AAII and Investor's Intelligence surveys) shows that "greed" is beginning to reach levels where markets have generally reached intermediate term peaks. 


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 consists of three down legs with reflexive rebounds in between.


The chart above shows the stages of the last two primary cyclical bear markets.  There were plenty of opportunities to sell into counter-trend rallies during the decline and reduce risk exposure.   

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?"

The point here is that 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


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.


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?


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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LawsofPhysics's picture

"Markets", what fucking "markets" is this shcmuck talking about?

GetZeeGold's picture



He's talking about free markets.......just skew it for the current market conditions.

Randall Cabot's picture

Farrell has been gloomy since S&P 666

Richard III's picture

As an aside, Farrell's fellow "Wall $treet Week" alum, Marty Zweig, passed away Monday.

TruthInSunshine's picture

Confidence Fairy Soweth & Reapeth


[W]ithout exception, throughout history, the masses do not understand there is a crisis until well after it has already begun, and they've already committed to many purchases, indebtedness and other forms of dis-saving, that they wouldn't have committed to had they known accurate information sooner.


Hence, the "confidence fairy," which governmental employees, politicians and business spokespeople all actively perpetuate in their own methods and by various tactices, is a serial and mass killer of efficient markets and rational economic behavior (as it severely distorts essential economic information that is relied upon by economic and market participants).

SafelyGraze's picture

rule 1: buy more apples.

why, you say?

Bolaji says it best:

If your company has been going up against Apple in the smartphone, tablet PC, or digital music player markets, be very afraid. Apple's return salvo may catch you completely by surprise. The company has been too quiet recently. Ominously quiet. The silence can only mean one thing: Apple will come out soon with another major product line that will redefine its market segment. That's my prediction.

How do I know? Apple's late founder, chairman and CEO Steve Jobs promised the company will be rolling out some extraordinary breakthrough technologies in the near future. I believe the process of rolling out the next product from Apple is peaking currently and we should see something compelling from the company within months.

I am fascinated with the growing speculations in the industry about the next products Apple might introduce for entertainment. These include a Siri or voice-controlled HDTV, an Apple iTV that transforms the television experience -- one that an analyst believes the industry isn't quite prepared for, or a direct invasion of the publishing and educational books market.

We may only speculate on what Apple has in mind next, but we can also be certain it won't be another humdrum product.


holy crap! voice controlled tv??!!!! that's amazing!

maybe they can invent additional features like allowing reader comments! and hyperlinks! and user generated content! that will totally transform the television experience!

and don't even get me started on educational books! that's a freaking gold mine!!

i wonder if there's a way to put any of the content into some sort of viewable medium that maybe you could watch on demand? and comment on? and rate? that would be awesome!


tango's picture

Be careful.  Saying anything positive about APPLE on this board will get the negatives flying.  Still can't figure out why guys who hate the narket and don't invest get so worked up about a company that provides an excellent product that people freely choose to buy.  One of the Tylers has a bee in his bonnet about Apple and it's the crowd mentality personified.   I, too, have heard rumors of something stunning (probably IPAD5 - lol).  But warning, if it was a replicator that could feed the world an provide unlimited free energy you'd hear bitching from the usual quarters. 

MillionDollarBoner_'s picture

Go on've talked me into down arrow coming up !:O)

Randall Cabot's picture

The Crash of '87 was before my time but a few years later I always looked forward to the Rukeyser Show, and Marty Zweig among others-scroll to about 6:40 to see Zweig's call:

Bankrupt from Belgium's picture

if you do not believe in the "markets" then why are you even reading the post ......

LawsofPhysics's picture

Please, for the western world, there is The Fed and that's it.  I read posts on ZH to front-run the idiocracy.  Many profitable trades.

Les Grossman's picture

Frontrun?!?!?!?  Haaaaaa!!!!!!!!!!!!!  This place is fillled with followers--mostly bitter ones.  You are one of them. Thanks for the laugh

LawsofPhysics's picture

Last time I checked, you do not have access to my portfolio.  Please, troll harder or let yourself be known in places like Park City, Deer valley, and Steamboat.  I vacation there frequently and will be sure to keep an eye out for you.

Everybodys All American's picture

The last time the Dow was at 14,000 was in October of 2007 and the US unemployment was 4.8%. That period of time was basically the peak of the markets and employment. Compare that to today. We have 7.9% unemployment and most expect it to go higher from here.

There is indeed no market to compare. This has become simply a fraudulent supported system by the Fed.


tango's picture

LOL  I remember the Democrats blasting Bush at the time.   "It's not real"  "Unemployment and deficits are too high",   Good for a laugh.  Strangely, we haven't heard from those folks lately.

MoneyThangs's picture

Guess this is why the markets are dropping like a rock today, so unfair

cheesewizz's picture

Here is the strongest sell signal to date....Were did this guy come from?

Hedgetard55's picture

The comments nailed his shill ass. They must have been ZHers.

NitneLiun's picture

I don't think they're ZH'ers. They are just people who actually have to drive a car and satisfy their basic nutritional needs.

fromPolandWithLove's picture

Great article, well don! Greetings from Malta :)

Cognitive Dissonance's picture

"10. Bull markets are more fun than bear markets"

Are we having fun yet?  :)

Winston Churchill's picture

Not as much as I have  with my clothes off.

donsluck's picture

They may be more fun, but I always do better in bear markets. It's a mystery to me.

Sudden Debt's picture

The public buys the most at the top and the least at the bottom.


It's like cudling after sex...

After you're fucked, all you wanne do is fall asleep...

NeedleDickTheBugFucker's picture

These are definitely NOT Vince Farrell's 10 investing rules.

Cash-NonCash's picture

The "public" has been jumping on the bandwagon dead last throughout recorded history.  Take the gold rush, for example. Hordes of "the public" showed up in Nome to find everything claimed.  December 2000 teck stock purchases- same story.  "Build a model airplane!" says the tooth fairy. Next thing you know the tooth fairy is a crazy glue sniffer and your daughter's knocked up!  Well we are not buying it. (Credit to Tommy Boy)

Ying-Yang's picture

Charts and history don't mean a thing when FED is buying 85 billion a month. Better question is what happens when they don't?

Dollar Bill Hiccup's picture

Look at the charts above. The rubber band goes SNAP!

raki_d's picture

Ok- so go long till they dont !
Nothing to worry. I will never ever fight Fed again !!

Son of Loki's picture

spooky. reminds me of the tech bubble before the Great Meltdown.

Sudden Debt's picture

To bad 99% of the population can't even remember what they had for dinner the day before!!


Oldwood's picture

There is only ONE sustainable investing strategy, invest in one's self.

jjsilver's picture

More theater from a mainstream shill. The fed is the market, and they make it do what they want, and what they want you to believe. Just like gold, all the shills are out in force with same lame arguments.

raki_d's picture

never fuck with Fed

dontgoforit's picture

Very well explained.  If I could only get my wife to agree - she's scared to death to 'move' any 401 or pension stuff around.

Dollar Bill Hiccup's picture


Please correct the title to BOB not VINCE. Very different guys.

Political_Savage's picture

Since I'm a pompous ass myself, I feel entitled to speak in this specific forum...


Just keep that in mind... now get back to making yourself feel important and mighty. Jackasses

Kreditanstalt's picture

"Getting investors to take profits"???

What if there aren't any?  What if, every time you bought in, in almost any sector and at whatever "low" price, the stock just continued declining? 

What if they continually told you "now is the time to buy" yet nothing ever goes UP?

What "profits"?   Come one....!

earleflorida's picture

Vince or Bobby is/are  PiecesOS,... always the consumate CNBC lying drone MF!!!

Edward Fiatski's picture

Buy when there's BLOOD in the streets. :-)

Most excellent article.

Herkimer Jerkimer's picture





I've got to concur.


If you really understand this premise, and I do, having sat on my ass doing nothing but reading ZH, and watching the markets for the last 2 years, and for perspective, reading the rest of the financial crap pages and watching MSNBC, this piece, once you have the, not understanding, so much as the confidence of experience, even just watching the market, you will see the wisdom in this brief piece.


Thanks Tyler!



kerneltrade's picture

Pretty nice article. Whether the author himself follows it ot not . Interesting graphs with explaining.

  What I understood  is that there is chance the market might still crank it up and start the slide down .