Taming the Lion: 100 Secret Strategies for Investing [Hardcover]

The Telegraph Investment column By Tom Stevenson (Filed: 16/11/2005) You've probably heard the market adage 'the trend is your friend'. It's been around so long and sounds so corny that, if you're anything like me, you've not given it much deeper thought. That's a pity because it is more profound than it sounds. This realisation hit me in a senior moment at the weekend while reading an excellent investment book, Taming the Lion by Richard Farleigh (published by Harriman House). Farleigh deserves a moment of your time because, despite an unpromising start to life (his early years were spent in the back of a pick-up truck driving round Australia with his itinerant, alcoholic father), he had made enough money by the age of 34 to retire to Monaco. Much of it came from running a successful hedge fund in Bermuda in the days before most of us had even heard of hedge funds. He was also a successful business angel in the early years of the 1990s tech boom and came through the subsequent crash with a sizeable fortune despite losing an estimated GBP100m. Taming the Lion is subtitled 100 Secret Strategies for Investing, most of which I'll leave you to enjoy by yourself (they're worth it). Worth pulling out, however, are Farleigh's thoughts on market trends and how to make money from them. The first point to make about trends is that by rights they should not exist. Economic theory says that markets are efficient and at any point in time reflect all relevant information. In other words the direction of prices in the past has no bearing on prices in the future - they are just as likely to rise as fall. The efficient markets theory is, however, largely rubbish, especially in less well-researched corners of the market like smaller companies, and Farleigh proved it years ago when he was trading for Bankers Trust in Australia. He showed that markets continued in an existing direction around 55pc of the time and reversed themselves the other 45pc. Now that might not sound much, but for an investor 10pc represents a massive advantage. If you get 55pc of your calls right and manage your portfolio properly by riding winners and cutting losers you will make a lot of money. Farleigh also showed that trends have been operating year in, year out for decades and, with hardly any exceptions, across a wide range of different markets from shares to commodities, bonds, indices and currencies. It's no wonder that trading with the trend - so-called momentum investing - has become so popular, especially with hedge funds. You only have to look at a handful of major markets to realise the power of trends. Farleigh cites the Dow over the past 25 years, the dollar-yen exchange rate which has fallen steadily from around 400 to around 100 and the big fall in interest rates around the world since about 1980 (see the first chart). In these and similar cases the market spent most of the time moving steadily in the same direction. All an investor had to do was go with the flow. There's a widely-held belief that markets always over-react but in fact they are very slow to react. Commodities prices illustrate this well. Economic growth in China was running at 10pc a year as long ago as the mid-1990s yet it took years for this to be reflected in higher prices for raw materials like copper and oil. You can see this with individual shares, too. Take a successful growth share like Majestic Wine, which traded at 55p five years ago and has risen steadily in the intervening period to 280p. There have been a few modest setbacks over the years but generally speaking the shares have risen in a fairly straight line. This is not as unusual as you might think. In an efficient market the bright prospects for Majestic, which have been known about for a long time, would have seen the shares rise quickly and then level out rather than rising steadily over the period (see the chart). There are at least three reasons why prices don't behave this way. First, markets are surprisingly slow to understand the full implications of new information. Big picture developments are, therefore, usually underestimated. Take the economic problems in Japan - it took the market 14 years to fully reflect the crisis from the 1989 peak to the start of the recovery in 2003. Second, price reactions are slowed by inertia and scepticism. People cling on to their old beliefs long after they are no longer valid. The herd instinct among investors and analysts is a powerful force and it makes them adjust their expectations slowly. Third, there is the counter-intuitive fact that in financial markets unlike other areas of the economy rising prices attract buyers. As prices go up we gain confidence that because others are buying it must be a good idea. Because trends are caused by big fundamental and psychological factors, they are unlikely to disappear overnight unlike the pricing errors or other anomalies that tend to be eliminated as soon as they are recognised. They are something to do with how the human mind works. So what does this mean for the investor? First, it argues against contrarian investing, which says you should look for opportunities where the market has overshot one way or the other. If prices move with the trend more than half the time, you start your search with an immediate handicap. Farleigh's advice is 'don't look for opportunities where the market's going to reverse, look for those where it's going to continue on its path.' Second, it suggests you are better off spending most of your time looking at the big picture and lining up your assets accordingly. Back the next big thing and as it becomes clear your judgment was right add to your bet (or cut it if you're wrong). Finally, stick with your winners. Trends go on for a lot longer than you might expect.

"An excellent investment book..."