10 Timeless Market Rules

Bob Farrell was the head of Merrill Lynch Research for decades, and during that time he established himself as one of the premier market analysts on Wall Street. His insights on technical analysis and general market tendencies were later canonized as "10 Market Rules to Remember" and have been distributed widely ever since. Let's take a look at these timeless rules and how they can help you achieve better returns.

Whether it's extreme optimism or pessimism, markets eventually revert to saner, long-term valuation levels. For individual investors, the lesson is clear: make a plan and stick to it.

Like a swerving automobile driven by an inexperienced youth, overcorrection is to be expected when markets overshoot. Fear gives way to greed, which gives way to fear. Tuned-in investors will be wary of this and will possess the patience and know-how to take measured action to safeguard their capital.

The tendency among even the most successful investors is to believe that when things are moving in their favor, profits are limitless and towers can be built to the heavens. Alas, as in the ancient Tower of Babel story, it's not so. As the first two rules indicate, markets revert to the mean.

Sharply moving markets tend to correct sharply, preventing investors from contemplating their next move in tranquility. The lesson: be decisive in trading fast-moving markets. And always place stops on your trades to avoid emotional responses.

The typical investor, John Q, reads the newspapers, watches market programs on television and believes what he's told. Unfortunately, by the time the financial press has gotten around to reporting on a given price move - up or down - the move is complete and a reversion is usually in progress: precisely the moment when John Q. decides to buy (at the top) or sell (at the bottom).

Basic human emotion is perhaps the greatest enemy of successful investing. By contrast, a disciplined approach to trading - whether you're a long-term investor or a day trader - is absolutely key to profits. You must have a trading plan with every trade. You must know exactly at what level you are a seller of your stock - on the upside and down.

Many investors are "Dow-obsessed," following with trance-like concentration every zig and zag of that particular market average. Broader averages offer a better take on the strength of the market. Instead, consider watching the Wilshire 5000 or some of the Russell indexes to get a better appreciation of the health of any market move.

Market technicians find common patterns in both bull and bear market action. The typical bear pattern, as described here, involves a sharp selloff, a "sucker's rally", and a final, torturous grind down to levels where valuations are more reasonable; a general state of depression prevails regarding investments in general.

This is not magic. When everyone who wants to buy has bought, there are no more buyers. At this point, the market must turn lower and vice versa.

This true for most investors - unless you're a short seller.

Many investors fail to see the forest for the trees and lose perspective (and money) unnecessarily. The above listed rules should help investors steer a more focused path through the market's vicissitudes.