I have been writing the Marcus Today newsletter for over twenty years and read something called "Farrell's Rules" over thirty years ago. There is an article about 'Farrell's Ten Rules' below which you might find interesting, but as I read them, I realise they are a bit old, and I'm sure we can do better.
Everybody has their system, conscious and unconscious. Given a stock code, we all tend to go through the same routine, through habit rather than brains, and the more experienced we get, the less we change that routine. But as Einstein supposedly said, “The definition of insanity is doing the same thing over and over again, but expecting different results.”
If your 'system' worked, and if my system worked, you wouldn't be reading the Marcus Today newsletter, and I wouldn't be writing it, we would all be on a yacht in the Caribbean surrounded by fluffy white towels and caviar. But we aren't.
As investors who are only interested in our own outcome (selfish but true) we really owe it to ourselves to constantly improve what we do, to get better, to progress, to be the best we can be, and the only way to do that is not to be so arrogant as to pretend we know what we are doing already, and keep doing it, but to allow ourselves, force ourselves even, to think outside the square, to have an open mind, to learn, to develop (y)our own investment rules.
Let's get you started.FARRELL'S RULES OF INVESTING
Bob Farrell was the chief stock market analyst at Merrill Lynch from the late 60s until 1992, a period that included booms and busts as always. He was a technical analysis pioneer, and amazingly, thanks to his results saw Merrill Lynch adopt and promote technical analysis at a time when Benjamin Graham's Intelligent Investor had the finance industry doing fundamental analysis and not much else.
Over the years, Farrell developed his now-famous Ten Rules – ten rules about investing – here they are:
FARRELL’S TEN RULES (Source Money Web – Felicity Duncan)
- Markets tend to return to the mean over time – Markets go up, and markets come down, but they never stay in one place. Farrell’s first rule is a reminder of the fact that markets never go up and up endlessly, nor do they fall forever. Whatever direction they’re headed, they are ultimately keyed to their long-term average return. Sometimes returns will be in excess of the long-term average, sometimes below, but the long-term average grounds the returns that investors can realistically expect. Investors that understand this are less likely to panic sell or buy into bubble.
- Excesses in one direction will lead to an opposite excess in the other direction – Markets will overshoot. Sometimes, they will run higher than earnings and dividends justify, and when that happens, they will likely go on to overshoot on the downside, dipping below the levels justified by earnings and dividends. This is an extension of rule one, and understanding these two rules will help insulate you from the urge to follow the herd up and down.
- There are no new eras – excesses are never permanent – This is an important rule. It seems that every few years, we are given a reason why things are different this time. Emerging markets will go up forever because they have huge growth potential. New technologies make the old rules obsolete, and tech stocks won’t follow the rules of other stocks. Farrell’s rule reminds us that it is never different.
- Exponential rising and falling markets usually go further than you think, but they do not correct by going sideways – When you see the market rising sharply, you know it’s headed for a top, and vice-versa. But the trend can extend far longer than reason would allow – it’s like the old saying, markets can remain irrational longer than you can remain solvent. Trying to time the rises and falls is very difficult, and more a matter of luck than skill. Further, when the correction comes, it’s never a gentle sideways process; corrections are usually as brutal as the excesses that precede them.
- The public buys the most at the top and the least at the bottom – Retail investors tend to pile into the market as it approaches its top and to bail out and stop buying as it approaches the bottom, thanks to those old favourites, fear and greed. Sadly, this is the worst possible investing strategy. However, it is a good indicator – when your parking attendant starts giving you stock advice and talking about his share picks, you know the market is close to its top.
- Fear and greed are stronger than long-term resolve – This is a corollary of rule 5 – on average, our emotions tend to be stronger than our logical selves. When the market is rising, even the smartest investor will start to feel the urge to buy, buy, buy! Similarly, when the market is falling, even the most iron-willed types will feel the need to divest completely. It takes a lot to buy when others are fearful, and sell when they’re greedy.
- Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chips – This is an interesting rule. The idea is that when a market rally is led by just a handful of big blue-chips, it is not a sign of real, deep market strength. Ideally, you want to see a broad-based rally with small- and mid-cap stocks participating in the rise. Rallies driven by a few big companies tend to fizzle out quickly.
- Bear markets have three stages: sharp down, reflexive rebound and a drawn-out fundamental downtrend – Bear markets often display a characteristic pattern. First, there’s a sudden, sharp fall. Then, there’s a rebound, and some of the losses are erased. Then, the market enters a sustained downturn that often overshoots (see rules 1 and 2).
- When all the experts and forecasts agree – something else is going to happen – This is more a warning about group-think than a hard-and-fast rule. Essentially, what Farrell is saying is that when everyone is, say, punting a particular stock, you should bring an especially critical eye to bear, and vice-versa. When a stock is unloved and criticised, there may be a buying opportunity, and when everyone loves a stock, it might be a good moment to sell.
- Bull markets are more fun than bear markets – This is true for everyone – investors, analysts, journalists, and regulators. People always want the good times to continue, so when you’re two years into a bull market, it’s extra hard to find anyone who wants to rain on the parade.
That’s Bob. Not to be outdone, here are ten more rules of investment.TEN RULES FROM MARCUS
- You will never overtake by following everyone else. You have to think for yourself. Do things differently. Do things a different way or forever stay in the pack.
- The one with the most information wins. Most of us can't be bothered to go the extra step, but it can only help. If you had to sell your whole super fund and were only allowed to buy one stock, how much work would you do before buying it. Now, why aren't you doing that with every stock?
- The only thing that moves the share price is the unknown. Assume that everything that is known, published, is already in the share price. So you will not make money looking at consensus forecasts, yields and PEs. Its the Catch 22 of the stock market. You have to guess the unknown. Its the unknown that makes a stock the best or worst performing stock next year.
- Don't be blinkered. You cannot trade a stock on fundamental analysis. The Intelligent Investor is not the golden bullet; a lot of people believe it is. Sure, knowing the quality and reliability of a company, if it is going to endure, is a key piece of information but a price is made up of value and sentiment not value alone, and sentiment can dominate for long periods. Use both fundamental and technical tools, any tools that help the cause, don't be blinkered.
- Stocks do trend. As much as the "you can't time the market" ostriches with their heads in the sand want it to be true that you can't time the market, so they can just buy something (or advise you to buy something) and do nothing (or provide no more advice) ever again, they are wrong. You can time the market, and you have to – we are over ten years after the GFC, and we are still not back to the pre-GFC level. Time is money. Don't time the market, and you can lose over ten years of returns in 18 months. If you can't time the market, you might as well give up now.
- Investment and trading is not about certainty, it's about probability. Research, analysis, technical analysis, any analysis you do before buying a stock can only, at best, narrow the probabilities of getting the price direction right, but it can go wrong the next day. Understand that, and you will rid yourself of pride, prejudice and denial. You have to entertain the idea that you could be wrong and be prepared to do something about it if you are. Not pretend you know.
- One good idea a year is a good year. If you buy ten stocks, at the end of a year, one will have gone to nothing. Three will do nothing. Three will be up with the market; one will be up 50%. One will double. And one will be a ten bagger (goes up 10x). It is the ten-bagger that creates all the performance. You have to be on the look out for the 'great' stocks, not just the good stocks everyone knows about.
- Be Spock. Emotion is a killer. It undermines every logical assessment of a stock. If you 'love' or 'hate' stocks, you have lost your objectivity. If you care about whether you have lost or made money, you are missing the point. The only thing that matters is what the share price is likely to do tomorrow, next week, next month, next year. The price you paid for it is utterly irrelevant.
- Its a game of odds. You will buy the wrong stock. You will fluke a great stock. Expect errors, do not define yourself by it. Your job is to do better than luck alone and with time and experience, you will.
- If it's not fun, intellectual, social, a hobby … give it away. If you come at the stock market out of necessity, begrudgingly, if you don't love it, don't do it. Far better you let someone passionate, experienced and resourced do it for you. One letter a year telling you how your investments went, at the cost of less than 2%, is better than endless days and weekends trying to do it yourself. For less than 2% you can get all your evenings and weekends back. It's not worth it if you even spend one weekend spent being shitty with your family because Wall St fell over on Friday night. (I know … so speaks the fund manager … let me do it for you!)
What are your 'rules of investing'?
Missed something? Have you got a favourite rule of thumb that's served you well as an investor? Let us know in the comments what your 'rules of investing' are.
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Marcus Padley is the author of the Marcus Today stock market newsletter. To sign up for a 14-day free trial please click here.
Absent the expertise to comprehensively analyse stocks and the insights fund managers obtain from frequent visits to companies, I have garnered respect for a handful of industry gurus and selectively follow what they recommend AND HOLD, subject to my own criteria and to confirmation within that select group. Thanks, Marcus, MH
Thanks Marcus, great rules. My most successful rule has been: invest in small companies with rising revenue who have recently become cashflow positive.
An excellent article and reality check however an over-riding consideration with equites investing is the direction of interest rates. This time last year the experts were saying get rid of your bond proxies as interest rates were on the rise in the US with RBA to follow. Today its buy the bond proxies as the world hold steady or reduce interest rates. The fundamentals of the Bond proxies has not changed with TCL, SYD, APA etc not changing their outlook but reaching record price highs as sources of income become strained.
you always offer good commentary Marcus, and express it in simple understandable terms - unlike many modern financial commentators. one rule I would add is look closely at recurring revenue. having managed companies for 20 years, I appreciate the benefit of being able to set the budget for the year and know where 90%+ of the revenue is coming from. you can then fix expenses to suit, and if growth from new business is slower or does not come at all, you can tighten expenses and still deliver solid profits. a company that has to keep winning major new contracts just to stay even, should be considered with great caution.
Great article Marcus. I have rules too that I try to stick to. The most important one is technical analysis trumps fundamental analysis every time I consider a buy or sell.
Sorry to be superficial but nice photos! What desk were you on? :-)
For income investing back testing PE and dividends over at least a decade is a good place to start to reasonably establish what may happen in the future, secondly I look at major shareholders (and their investing history) third item is board and management track records both current and former, fourth item is to have a hard look at product and its future, i.e. is it likely to be victim of a disruptive competitor? Fifth on the filter is to look at is, if the company is resting on its laurels or anticipating technological change, doing its own R&D and continually upgrading. This has worked for me and usually results in buying boring old dividend payers. For a bit more risk I try to stick to my knitting and as I have spent my life as a civil and mining contractor and miner in own right tend not to touch technology, pharma, medical but stick to miners, filtered out of hundreds I have only five that make the grade in last two years
One of those is Wood Mackenzie's equity desk in London circa 1985 and the other is Panmure Gordon in London circa 1992
Thanks Marcus. Any ideas on how you reconcile "Let your winners run and sell your losers" with "Sell high to lock in your profits". Maybe these 'rules' are just helpful guidelines?