Three Rules of Investing from Ned Davis

I have written a number of times on this blog about Ned Davis Research (NDR).

NDR maintains a massive database of economic and market data to make investment recommendations. It goes without saying that I am a big fan of their work.

However, I have never heard the founder of NDR speak - until yesterday.

Ned Davis was in town to give an hour-long talk to the Market Technicians Association, and I was in the audience.

As you might expect, he was an engaging speaker, and had a number of interesting and sometime amusing anecdotes about some of the experiences he has had in investing for nearly 40 years.

I won't go through all of the points he raised in this talk, but I thought I would share his three rules for stock market investing:

First: Don't Fight the Tape. Ned noted that most investors lose money by trying to go against the prevailing trend of the market. It sounds obvious, but if the charts indicate that the market wants to go higher you need to be invested. And, of course, when the charts turn ugly, you should head for the exits, and stay there until opportunity appears again.

(Right now NDR indicators that the market remains in an uptrend, even though the momentum is less than it was a year ago. They are still overweight equities.)

Second: Don't Fight the Fed. When the Federal Reserve is pumping money in the system, and keeping interest rates low, this is nearly always positive for the stock market. Ned noted that this is not a perfect rule: Japan has been adding money to their economy for 20 years, with no positive effect on the stock market, but he thinks this is unusual.

(Even if QE2 disappears, the Fed is not likely to raise interest rates for many months. In fact, Ned even raised the possibility of QE3 if the economy starts to sputter in the fall).

Third: Be Wary of the Crowd at Extremes. By this Ned means that whenever crowd sentiment becomes overwhelming bullish or bearish on a sector you need to be concerned. Ned uses data from the American Association of Individual Investors (AAII), since they are actually investors, rather than consumer confidence numbers.

(This indicator is flashing yellow at this time, since the most recent AAII survey indicates that 73% are bullish on the prospects for stocks. If this bullish sentiment continues to creep higher, Ned would begin to think about reducing stock positions).

Good thoughts from a market veteran.