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Taming the Lion


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Introduction A brief biography A day in the life 1 - Markets 1.0 The different markets have many useful similarities 1.1 Fear the market 1.2 Markets are more efficient than generally acknowledged 1.3 Market opportunities are disappearing 1.4 The markets can overwhelm government intervention 1.5 The market is strengthened by speculation 1.6 Respect the market not the experts 1.7 Most professionals are not outguessing the market 1.8 Listen and read very critically 1.9 Understand recent history 2 - Comparative Advantages 2.0 To outperform the market you need a comparative advantage 2.1 Everybody is a hero in a bull market! 2.2 Never stray from your comparative advantages 2.3 A small percentage advantage is enough to outperform the market 2.4 Test the advantage over time and make changes slowly 2.5 Financial markets advantage #1: Information 2.6 Financial markets advantage #2: Original analysis 2.7 Financial markets advantage #3: Brokers and bankers have extra information and free insurance 2.8 Financial markets advantage #4:Understanding market behaviour 2.9 The Strategies are based on six types of market behaviour 3 - Risk 3.0 Manage and embrace risk 3.1 Good ideas can lose money 3.2 Asymmetry has fooled a lot of investors 3.3 Wild swings and losses are uncomfortable but they may offer the best rewards 3.4 Diversify 3.5 Assess risk - and then double it 3.6 Risk adjust results after the trade 3.7 Qualities of the successful trader 3.8 Trading pressure increases with amount at risk 3.9 The trader's dilemma - the stop loss? 4 - Patterns and Anomalies 4.0 Look for patterns and anomalies 4.1 Choose the right markets 4.2 The share market dilemma 4.3 Crisis situations almost always provide an opportunity 4.4 Short term interest rates will tend toward the inflation rate plus the economic growth rate 4.5 Government bond markets for the major economies are not prone to crashes 4.6 Currencies: two economies and fact or fashion? 4.7 Some markets are driven by supply 4.8 Property prices often lag stock prices 4.9 Charts are the astrologers of the markets 5 - Big Ideas 5.0 Markets are slow to react to structural influences 5.1 Look for the next big thing 5.2 Ignore obscure theories and observations 5.3 Only invest in the broad markets when they are in line with the prevailing economic environment 5.4 Be methodical - use a checklist to quantify and add rigour to a view 5.5 Buy stocks when economic growth is strong and inflation is weak 5.6 Buy bonds when inflation and economic growth are both weak 5.7 Buy commodities when inflation and economic growth are both strong 5.8 Few assets benefit when inflation is strong and economic growth is weak 5.9 You are unlikely to out-analyse the analysts 6 - Small Companies 6.0 Small companies offer more opportunities than large companies 6.1 The quality of a company's management is by far the most crucial factor in determining its success 6.2 Determining the fair valuation is more difficult with small companies 6.3 Clearly identify the comparative advantages 6.4 Be sure the business is sustainable 6.5 Good products don't always sell 6.6 Growth puts strains on small companies 6.7 Be sure of a route to exit and adequate cash resources 6.8 Shareholders can help unlisted companies 6.9 Be pragmatic with due diligence 7 - Price Behaviour 7.0 Prices go further than expected 7.1 Forget the old price 7.2 People often misjudge probability and logic 7.3 A price is an average of possibilities 7.4 The probability can be asymmetric 7.5 Be nervous when a market doesn't rally on good news 7.6 Don't day trade! 7.7 Avoid trading in options if you do not understand their pricing 7.8 Back your hunches with at least a small investment 7.9 Features of good trading models 8 - The Understanding and Use of Trends in Prices 8.0 There is statistical proof that market prices trend 8.1 Trends operate across commodities, currencies, interest rates, stocks and property 8.2 Trends have been in operation for a long time 8.3 It is not true that markets usually overreact 8.4 Trends are resistant despite being well-known 8.5 Trends represent the gradual dispersal of information 8.6 Price reaction is delayed by inertia and scepticism 8.7 A rising prices attracts buyers 8.8 Economic cycles breed market cycles 8.9 News against the trend is often ignored 9 - Market Timing 9.0 Combine fundamentals with price action 9.1 Ignore the noise in price movements 9.2 Don't be a hero - do not buy falling markets 9.3 Trade with the trend - wait for the trend before you enter the market 9.4 Add to winning trades, not losing trades 9.5 It is safe to be with the consensus 9.6 Do not use price targets or time limits 9.7 If the fundamentals have changed adjust the position accordingly 9.8 You will not get the high or the low 9.9 A powerful model shows probability is on your side 10 - Avoiding Temptation 10.0 Know when to stay out of the market 10.1 Identify what is difficult about the existing environment; it may change 10.2 Monitoring trends may alert you to opportunities you wouldn't normally find 10.3 With success, bank some profits 10.4 Negotiation is an art 10.5 The evolution of the con artist 10.6 Wealth preservation is not simple 10.7 Be sceptical of sophisticated retail products 10.8 Management and brokerage fees should be minimal in a passive portfolio 10.9 Follow these rules and be part of the hedge fund (r)evolution

About the Author

Richard Farleigh was born as one of eleven children in the country town of Kyabram in Australia in 1960. He was placed in foster care at an early age and grew up in Sydney. Despite a difficult start in life and being diagnosed as backward at the age of 5, he went on to win a scholarship to study economics and econometrics at New South Wales University, and graduated with first class honours. Farleigh worked briefly in the Research Department at Australia's central bank, the Reserve Bank of Australia, working on economic modelling. At 23, he passed up the opportunity for an academic career in economics and joined a leading investment bank, Bankers Trust Australia. There he worked for a number of years in designing and managing swaps and other derivatives. During this period he demonstrated a strong ability at trading financial markets, and was then appointed head of the bank's proprietary trading desk, which achieved spectacular results by predicting big picture trends and by using a trading model he developed. In 1992 he was hired as head of a very powerful private hedge fund in Bermuda, which had searched the world for the best candidates. He was able to retire at the age of 34, and moved to live in Monte Carlo. From there he began investing in small companies which were mostly situated in the UK. Over the years, he has invested in over 50 start-ups, many of which have floated or been acquired. One such venture has been Home House, a Georgian mansion which Farleigh as a backer and Chairman, help to convert into one of London's most fashionable and successful private members' clubs. Despite his early retirement and being affected by the tech wreck in the year 2000, Farleigh has become substantially wealthy and he has been named as one of the top ten entrepreneurs in Europe. Apart from being keen on tennis, skiing and boating, Richard is an internationally ranked chess player, and has represented Bermuda and Monaco in the Chess Olympics. Richard is a former 'Dragon' of BBC series Dragons' Den.


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.

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