By: Ilan Levy-Mayer, Cannon Trading VP @ Forex Magnate
October 14th, 2014
Many people have commented about the stock market run of the last few years, its widely perceived “Quantitative Easing” connection, and much more. Some of these people are smarter and more knowledgeable than me when it comes to economics but then again, sometimes the stock market does not react to economics, intuitive correlations, or “brains” but does what it wants to do…..
If you were one of the bulls who bought any significant correction in the past 5-6 years you would have done well, as QE just fueled the stock market into new highs.
To me the big question is: Does this represent the highs for the next few years?
Statistically the right answer is no. There is a higher probability that stocks will recover and make new highs than the chance that this may be the high for the next few months/few years.
However........
Bob Farrell was a legend at Merrill Lynch & Co. for several decades. Farrell had a front-row seat to the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987's crash.
He retired as chief stock market analyst at the end of 1992, but continued to occasionally publish.
1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people's heads. It's easy to get caught up in the heat of the moment and lose perspective.
2. Excesses in one direction will lead to an opposite excess in the other direction
Think of the market baseline as attached to a rubber string. Any action to far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.
3. There are no new eras -- excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots. Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get cut in half.
As the fever builds, a chorus of "this time it's different" will be heard, even if those exact words are never used. And of course, it -- Human Nature -- never is different.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don't expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction -- eventually. comes.
5. The public buys the most at the top and the least at the bottom
That's why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing.
Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.
....Read More by filling out the form below.
Market Rules by Bob Farrell
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