The closer you get to retirement, the more important it becomes to avoid nasty, major stock market moves down, and capture those lucrative stock market moves up.
But maybe you’re wondering how to know if the stock market will go up or down over the next few years with a higher degree of likelihood?
While it may not seem like it, the markets move in somewhat predictable and logical cycles based on the economy.
There are measured numbers and certain ways to see when the stock market is overvalued or undervalued, as you’ll see below.
Not only this, but human behavior gives a lot of valuable clues about where the markets are headed.
Of course, no one can know the exact time frame or amount the stock market will go up or down. However, as my dad taught me, if you can ease into markets near the bottoms and out near the tops, you’ll do well.
Everyone knows that when you buy groceries on sale, you’ll get more for your money. This same logical and well known principle is true with investing, but it gets overlooked with long term buy and hold investing. Yet it is particularly important after periods of increasing stock prices.
In this post, I’ll address the clues the stock market provides, assembled by an iconic stock analyst, to help know where the market is headed with a higher level of probability.
Note that for younger, long term investors who have decades to allow their stock investments to compound and grow slowly through the ups and downs, knowing if stocks are moving up or down over the next few years is much less of an issue than it is for an investor over 50 cruising toward retirement.
If you want to be smarter about bear markets, you’ll love my post, Predictor of Bear Markets, where I display and explain the most comprehensive research data I have found on this often avoided topic. Be sure to check it out after you read this post which has other important insights and facts about stock market cycles.
How to Know If the Stock Market Will Go Up or Down
There are clear signs for whether the stock market is more likely to go up or down over the next few years at any given point in time. Remember, with investing, we only have probabilities. That is all Warren Buffett has, that is all financial advisors have, and that is all you and I have.
So, let’s make the most of probabilities in guiding us toward whether the stock market will go up or down to aid in preserving and building wealth.
Why Investors Lose Money in the Stock Market
From my own investing and working as a financial coach, I’ve learned that investors believe they can have absolutely no idea if the stock market is going to go up or down over the next few years. This happens because of two main reasons.
First, investors let emotions instead of logic lead their investing.
Second, investors get caught up thinking that what has happened recently will continue to happen for the next few years. This is called recency bias. Click here to read my post Wealth Building Steps with more on Recency Bias.
Just the opposite is true! In the years following an extended bull market (and overvalued stocks), the market is much more probable to go down in the subsequent years. The market must return to the average as you’ll see below.
On the other hand, in the years after a bear market (and stocks are cheap), the market is much more probable to go up.
Here’s an example. As an older investor, I well recall the end of the 1990’s when the stock market had been going up for many years. Smart financial experts were saying that investors should not expect that the first 2000 decade would repeat the stellar stock market returns of the 1990’s.
They were certainly correct, with two devastating bear markets in the first decade of the 2000’s! This left stocks undervalued.
So, this was followed by a stellar bull market which began in 2009.
Bob Farrell’s 10 Market Rules to Remember
In this post I’d like to share Bob Farrell’s 10 Market Rules to Remember which can significantly help every investor gain a much better understanding of the overall stock market, and whether it is more probable to go up or down over the next few years based on logic.
If you’re over 50, like me, it pays to step back from your own net worth spreadsheet (I know you have one) and look at the big picture. Big pictures will reveal a lot that can keep you on track to reach your retirement goals with a smile on your face.
Wealth Building Tip – Ironically, the rules of avoiding buying stocks in overvalued markets tends to be forgotten during overvalued markets and remembered when you can buy stocks for dirt cheap.
Here are Bob Farrell’s 10 Market Rules to Remember.
1. Markets Tend to Return to The Mean Over Time
Most stock investors know that there is an average amount the stock market moves up over time. This average is the reason people invest in the stock market in the first place. They plan to get a certain return based on what stocks have done in the past.
Over very long time frames, this annual stock market return is 10%. (Remember, this often used return number includes dividends reinvested, and many retirees don’t plan to reinvest dividends since they may want to live off dividends.)
A mean is a type of average. While a 10% average annual return sounds great, the occasional wild swings down that contribute to that average aren’t too great.
A perfect example is the stock market crash in October 2007 through March 2009 when the S&P 500 dropped about 50%. You can easily see how different it feels to think about making 10% a year on the stock market vs seeing your stock portfolio decline by 50%, but it helps to know that stock prices change to mean back toward the average.
Returning to this average, or mean, is called mean reversion, theory statistician Francis Galton first observed. It explains the way normal events follow extreme events. (1.)
During the pain of bear markets, it’s important to remember that stocks will eventually revert to the average by going back up.
Likewise, during the plentiful times when stock market values have swung up higher than the average valuation, it’s smart to remember that they’ll need to swing way back down under the average to get back to the usual average.
Not only can this mean reversion awareness ease the pain of net worth declines that occur during bear markets, you can actually tweak your investing decisions with this information to help build wealth by buying low, and selling higher, in long term trends.
This is so logical. What, then, keeps individual investors from factoring this reality into their stock market investing decisions? The herd mentality, lack of focus, recency bias, the emotions of fear and greed and lack of knowledge about stock market cycles all contribute to losing money in stocks.
Knowing that markets revert to the mean helps you know if the stock market is more likely to go up or down over the next few years. You can simply look to see how far the market has swung away from the mean, and in which direction.
2. Excesses in One Direction Will Lead to An Opposite Excess in The Other Direction
After bear markets, you hear investors state that they’ll never buy stocks again. Everything in the news is about the losses that horrible investors have had. People HATE stocks to an excessive level even though they can be bought very cheaply.
Near the end of bull markets, however, everyone LOVES stocks. It feels like the great stock market performance will go on forever even though stocks are overpriced based on history.
This excessive optimism is called “Irrational Exuberance” and it drives stocks to levels that are no longer supported by the true valuations of the companies in the stock market.
Below are some examples of stock market excesses that you may well remember, as I do.
Remember real estate in 2006? Real estate investing, and lending, was clearly excessive. Real estate and the financial firms lending money for real estate had to swing in the opposite direction to return to “normal” pricing following the excesses.
The tech boom in 2000 was also excessive. The stock index which held the cutting edge technology companies was the Nasdaq. It increased a whopping 85.59% in 1999! This was clearly excessive.
Then, the Nasdaq declined over 39% in 2000, then over 21 in 2001, and then over 31% in 2002. Ouch! These downswings were obviously excessive, so in 2003 the Nasdaq swung back up just over 50%! (2.)
See how logical the return to normal pricing is after the excessive periods? This isn’t rocket science. Of course, hindsight is 20 20, but wild excesses such as these make it clear that the stock market will need to go up or down to shake out the excesses.
Do these wild swings matter for stock market investors? Only you can decide what is right for you. (If you work with a financial advisor, this can be a great conversion to have with her.)
3. There Are No New Eras — Excesses Are Never Permanent.
This investing rule is tied to the popular phrase that fuels many excessive valuations, “This time is different.”
Heading into 2000 in the midst of the tech bubble, everyone thought that overall business fundamentals were, in fact, different, because we would all be using new technology which would change the world forever.
As it turns out, we are, but even technology company valuations are affected by supply and demand, by corporate leadership, and by the economy.
There are no new eras. While the next time may be a little different, stocks return to valuations which make sense in relation to their financials, and to historical norms.
4. Exponential Rapidly Rising or Falling Markets Usually Go Further Than You Think, But They Do Not Correct by Going Sideways
The way I state this stock market rule is that trends last longer than you think. I have learned this truth time and time again during trends that are both up, and down.
All along bear market declines stock analysts are interviewed in the media explaining how the market will stop dropping soon yet the trend continues longer than expected.
And all along the way up, the stock market is climbing a wall of worry, which is another popular saying. Then the stock market goes higher and longer than anyone thinks it will.
I do, however, recall two exceptions to this stock market rule. The first was the fast bear market that began in October 1987 with the sudden one day steep drop.
The second was the bull market between 2003 and 2007. The average bull market lasts 9.1 years, so a bull market that lasted only a little over 5 years in the mid 2000’s seemed too short following the nasty 2001-2003 bear. (3)
The second part of this stock market rule is that markets don’t correct by going sideways. This implies that markets must go up or down, significantly, to return to the norm, or the mean.
Click here to read my article Investment Strategies Used for High Net Worth Clients with 5 risk management strategies a top financial advisor uses for his clients.
5. The Public Buys the Most at The Top and The Least at The Bottom
Yes, that’s us – individual investors that Bob Farrell is referring to. For most investors wondering how not to lose money in stocks, if we can correct this pattern, we’re well on our way to making money from stocks instead of losing money from stocks. Sell at the top and buy at the bottom.
It’s so easy, especially give the obvious stock market rules you see here from Bob Farrell. So why don’t investors do it?
Again, the herd mentality is so strong in humans. It is almost impossible to go against the herd.
Also, from my wealth coaching, I have also seen that one reason investors do this is because they don’t feel knowledgeable about investing.
The fact is that it’s easier to make smart, independent decisions when you are knowledgeable. This just makes sense with anything in life.
When you understand investing, it’s easier to see that the same high quality stocks that cost 50% less a year or two prior have a higher probability of increasing in value. Likewise, it’s easier to not allocate 60% of your portfolio to stocks when the market is overvalued.
Then there’s lack of focus, especially during good times. We’re all busy with life. When stocks are going up in value, it’s easy to focus on urgent needs over something that’s working without our attention.
Wealth Building Tip – When you don’t understand investing, the emotions of fear and greed guide your investing decisions instead of logic.
6. Fear and Greed Are Stronger Than Long-Term Resolve
Most people invest based on deep rooted beliefs about money instead of the logic you see in Bob Farrell’s 10 Stock Market Rules. These beliefs are usually related to childhood. Beliefs trigger emotional investing instead of logical investing.
Yet, it’s hard to not be fearful about running out of money when you picked up on fear from depression era parents.
Plus, as humans, fear is hard wired into our brains from the cave dwelling days. We had to be fearful to survive. Now, most of us don’t have to be fearful to survive, so we invent things to be fearful about. Running out of money is an excellent target.
What if you shifted that fear into learning more about investing? You’d be able to make better, more logical decisions.
On the opposite end of the emotional spectrum, it’s hard to get greedy when you see that everyone you know has built wealth from the latest stock bull market. This leads investors to get into stock markets near the top of the cycle instead of waiting until stocks are cheap again.
The fear of missing out overcomes logical investing.
Wealth Building Tip – Step back and ask yourself if you are making investing decisions based on logic or from emotions.
7. Markets Are Strongest When They Are Broad and Weakest When They Narrow to A Handful of Blue-Chip Names
With this rule, think of FANG stocks, the darlings of the bull market that began in 2009. Facebook, Amazon, Netflix and Google fueled this bull market. These few companies accounted for a very disproportionate share of the overall stock market value in the later stages of this bull market.
Weak markets that are concentrated on a few key stocks tend to go down while strong broad markets tend to go up.
8. Bear Markets Have Three Stages — Sharp Down, Reflexive Rebound and A Drawn-Out Fundamental Downtrend
This stock investing rule will be important to remember during bear markets. Markets tend to fall hard and fast once the institutions begin selling.
Then the markets head back up several times retesting prior levels based on technical analysis. During this time, there are little up trends inside of the large overall move down. These little up trends can give investors a good opportunity to sell stocks off the lows.
But don’t get too caught up in the small trends within the overall larger moves up or down since these are tricky for the even the best of the best investors.
Instead, focus on the big picture asking if stocks are overvalued, fairly valued or undervalued. Data is easy to get to provide the answer to this question.
Image Source – RealInvestmentAdvice.com
In the last stage that Bob Farrell refers to here, the prices drop so the numbers make sense again to draw buyers back into the markets. This stage is based more on fundamental analysis. Again, you can see the logic here.
Wealth Building Tip – There are 2 types of analysis, fundamental and technical. Technical is based on looking at charts and applying technical indicators. Fundamental, on the other hand, is based on good old fashioned financials tied to profits and growth.
9. When All the Experts and Forecasts Agree — Something Else Is Going to Happen
In March of 1998 my mother and I toured the floor of the NYSE (New York Stock Exchange) when we were in NY celebrating her 73rd birthday. (We dined atop the World Trade Center, and my heart swells as I type this, over both the loss of my mother and the many lives lost on September 11, 2001.)
The NYSE was giving out Dow 10,000 hats anticipating that the Dow would pass 10,000 for the first time ever that very day. It was wild, and the excitement was contagious.
The seasoned broker who took us around the NYSE floor said to us “If you have money in the stock market, take your profits now. This won’t last much longer.”
The market continued its’ uphill climb for 2 more years. Trends last longer than you think, as stated above, but also, when the experts agree, something different is going to happen.
In the bull market which began in 2009, there were a lot of financial experts saying the market fundamentals were approaching a bear market in early 2017 and beyond. The market kept climbing.
Be aware that many financial advisors are discouraged from focusing on stock market crashes. I admire the financial advisor who confidently and realistically discusses bear markets and overall market valuations.
The reality is that bear markets are as sure as death for stock market investors. Why gloss them over instead of accepting them as a reality and taking advantage of them?
When all the experts predict the market will go up, the probability is higher that it will go down. When the experts all agree the markets will go down, it’s more likely the market will go up.
Here’s my video for How to Know if the Stock Market Will Go Up or Down with these 10 steps.
10. Bull Markets Are More Fun Than Bear Markets
This is the attitude that prevails the media, and hence, the general public during bull and bear markets.
However, for logic based investors who are prepared for the bear market, with extra cash on the sidelines waiting to be invested at cheaper prices, bear markets can be an opportunity to build wealth. Buying assets cheap can be quite fun and lucrative.
Click here to read my article How to Build Wealth where I write about the cheap asset method of wealth building.
For investors who are not invested in bull markets, the frustration of not being in the market can be no fun at all. So, bull markets are fun for those who have created wealth from them but the same can be said for bear markets.
Ideally, investors will consider market valuations before investing in anything, allowing them to capitalize on both bull and bear markets. Why not?
How to Know If the Stock Market Will Move Up or Down Summary
You can see how Bob Farrell’s 10 Market Rules to Remember are all beautifully intertwined. One rule supports the other rules in a way that provides substance and truth.
Incorporating these 10 often overlooked realities into your investing can help you know if the market will go up or down within a higher level of probability.
Remember, using probability to your advantage can guide you to build wealth at any age.
Click Here to Get My eBook with my Favorite 9 Wealth Building Strategies
Remember to read my post, Predictors of Bear Markets. If you liked this post, you will love the research I share there!
- Joe Marwood – https://jbmarwood.com/mean-reversion-trading-strategy/
- First Trust Portfolios LP
This information is for education only and not to be taken as financial advice. You are the person responsible for your money.