Fallibility, reflexivity, and the human uncertainty principle. George Soros*. Soros Fund Management and the Open Society Foundations, New York, NY, USA. When I first read The Alchemy of Finance by George Soros, I thought his “theory of reflexivity” was absurd. It seemed to be an ex post facto. In epistemology, and more specifically, the sociology of knowledge, reflexivity refers to circular . Economic philosopher George Soros, influenced by ideas put forward by his tutor, Karl Popper (), has been an active promoter of the.

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He wrote the book, The Alchemy of Finance, to communicate his theories on the rdflexivity and why he had so much success. George Soros is a philanthropist, author, investor, and hedge fund manager of the very widely known Quantum Fund. He is arguably the best speculator of all time and is very well known for his bets against currencies.

If there is one thing that Stanley Druckenmiller says George taught him, it was that when you see something, bet big. Here is a first-person account of a brief conversation between Stanley Druckenmiller and George Soros right before they added immensely to their short position:.

What you described is an incredible one-way bet. And that is part of the reason why George Soros was so successful. He was willing to bet really big when he found something that he felt he was confident in and he got it right when it counted. And if a trade was about to go in the wrong direction George did have his own ways some questionable of being able to identify soroa advance his errors and why that may lead feflexivity his position moving against him.

George Soros wrote the book The Alchemy of Financ e and it acts as somewhat of an grorge to his investing days, an experiment from his investing days when he was running the Quantum Georte, and his theories about markets — including his theory of reflexivity.

He also adds a lot of the secrets that are responsible for his success. Reflexivity is the theory that a two-way feedback loop exists in reflexivuty investors’ perceptions affect that environment, which in turn changes investor perceptions.

George Soros, Reflexivity, And His Success | Seeking Alpha

Human thoughts and emotions are what drive security prices. Since security prices are influenced by human feelings and opinions, markets are subjective rather than objective. A tree is objective and is a part of physical reality.

We can see it, touch it, and we know a tree when we see one. These thoughts and perceptions are subjective because they are inside our minds. In other words, they are abstract. This makes the collective thinking of all humans in the market effect stock prices and the results of their thoughts on stock prices further affects how market participants view stock prices.

Their perceptions of reality, not reality itself, affect stock prices and then this perception gets priced into markets and these perceptions end up affecting the fundamentals of the underlying companies.

On the one hand, participants seek to understand reality; on the other, they seek to bring about a desire outcome. The two refllexivity work in opposite directions: The two functions can interfere with each other by rendering what is supposed to be given, contingent.

In order to get a better idea lets think about the two ideas below and how each participants behavior influences the other. But imagine if the golfers before reflexivihy hit really good shots onto the green and these really good shots changed the dynamics of the course.

Good shots now made your shot more difficult or worse shots from the golfers hitting before you made your shot easier. This would make the game of golf much more similar to how markets work because the efforts of investors to succeed and invest well in the market before you can make it harder for others to enter the market and do well.

And when a successful idea or strategy gets geeorge it becomes harder to succeed if lots of other market participants are copying it. The result of so many smart investors starting up funds has made it harder for new funds.


There are less opportunities now because more smart people are looking for them. Erflexivity the initial group of people buy into an asset at a lower price, the demand pushes up the price which lowers the prospective returns for new investors. It is aoros on the thinking participants’ perception and the feedback loop that results from that thinking. He knew that market participants are prone to be irrational, and that they make mistakes and have emotions.

While investing or trading in the markets, George starts from a position that every human endeavor is flawed and he also claims that market participants are always refpexivity in one way or another.

A Short Note On George Soros’ Principle Of Reflexivity

To outperform the market, it helps investors to try and recognize what the flaws of the other players in the market are in advanced. The flaws may be revealed only after the construct has come into existence. That is the key to understanding reflexive processes. Recognizing the flaws that are likely to appear when a hypothesis is becoming a reality puts you ahead of the game. They sorps apply to the regulators who are market participants themselves and are just as human as all of the other participants.

Bigger issues may even arise when the central banks make mistakes because their policies affect markets the most and in addition they seem to forget how fallible they actually are. But they, too, are fallible. Although they’re supposed to be above the fray, they are also participants with their own institutional interests and biases.

There are a lot of views of the market that state that stock prices tend to approach an equilibrium but George Soros, as you see from the next couple of sentences, has a totally different view of equilibrium and market prices.

There is little empirical evidence of an equilibrium or even a tendency for prices to move toward an equilibrium. The concept of equilibrium seems soors at best and misleading at worst. The evidence shows persistent fluctuations, whatever length of time is chosen as the period of observation.

Admittedly, the underlying conditions that are supposed to be reflected in stock prices are also constantly changing, but it’s difficult to establish any firm relationship between changes in stock prices and changes in the underlying conditions. George concludes that his theory of reflexivity is best to be used along with fundamental analysis, rather than on siros own. Fundamental analysis is used to try and find the underlying value of a security based on economic, financial, and other qualitative and quantitative factors but if you only use this method then you would have been shocked to see internet stocks approach levels of over times earnings during the NASDAQ bubble in In principle, the two approaches could be reconciled.

Fundamental analysis seeks to establish how underlying values are reflected in stock prices, whereas the theory of reflexivity shows how stock prices can influence underlying values. Despite his success, George never found being a hedge fund manager easy.

He constantly second guessed himself. Here is what George wrote in the journal that he kept back on October 1, when he thought that he could take a month away from being active with his portfolio:.

If so, I am prepared to sit out georg rally in stocks sotos bonds, especially as I am going to China for a month. I am now on my way back to New York after spending a day in Tokyo.

Reflexivity (social theory)

I am now badly caught. It is clear that I ought to get out of reflexicity market, but how and when? I don’t know what to do because my knowledge of the Japanese market is extremely limited.

I expect to soris a heavy price for my ignorance. I find it somewhat embarrassing to get caught in the “bust of our lifetime” while writing about the “boom of our lifetime. I believe the collapse of the Japanese stock market will prove to be one of the landmarks of contemporary financial history. And he was right about the Japanese stock market being one of the landmarks of contemporary history. At the peak of the Japanese real estate bubble, the land under the Imperial palace was worth more than the state of California.


That’s an incredible stat that summarizes how overvalued Rflexivity real estate got.

The temptations to be in the hottest gelrge of the day are high when your time horizon is short and you are looking to make big returns. If technology stocks are the hottest trend like they were during the NASDAQ bubble, refpexivity the market index geflexivity you compare your returns with has these technology stocks in them, then you are highly likely to under perform unless you go long technology reflwxivity despite their high valuations.

What Soros acknowledges later, to his surprise, was that the irrational exuberance in the Japanese real estate and stock markets went on for another three years after he wrote those lines. Another difficulty he had with being a hedge fund manager was how he identified with his portfolio.

That is what makes financial markets such a good laboratory for testing your ideas: The objective evidence is reinforced by emotions. Short on knowledge, I relied heavily on the pain mechanism. George was very curious about markets and really enjoyed testing his ideas to try and figure out how they worked. I hope that this summing up will bring it to fruition.

I believe his curiosity and thirst to georgw markets so much is what made him less afraid of failure than so many other people and it helped him bet big. He was betting more money with my ideas than I was. And George relied not only on cognitive factors when investing but on body signals as well. It is only after a period of time that my mind finally yeorge what is going on. A very simple example when this happens to me is when the room I am working in gets too hot all of a sudden and then my work productivity starts to drop fast.

My body gets a very restless feeling and it becomes uncomfortable for me. Then after a couple of minutes my mind starts to realize that it is really hot and I need to turn on soors AC or open a window. I used to treat it as a warning sign that something was wrong in the portfolio.

It used to occur before I knew what was wrong, often even before the fund began to decline in value. That is what made it so viable as a signal I knew that I did not act on the basis of knowledge; I was acutely aware of uncertainty and Veorge was always on the lookout for mistakes. As I mentioned earlier, it is when I did not know the flaws of my positions that I had to worry.

When I finally discovered geirge was wrong my backache usually went away. Managing money is hard enough as it is and Reflexivitj was managing billions of dollars which made it even harder. There is one last piece of advice I have from his book that George says helped him a lot. I imagine this book being a lot harder to write for George Soros if he had never done this. So I will leave you with this last piece of advice that I myself have tried to utilize as much as I can.

My arguments may not strike the reader as particularly well organized, but they are certainly more consistent than they would have been if I had not gorge the trouble to formulate them in writing. I wrote this article myself, reflsxivity it expresses my own opinions.

reflexivihy I am not receiving compensation for it other than from Seeking Alpha. I have no business relationship with any company whose stock is mentioned in this article. This article summarizes his thoughts from his book that led to his success.

It also summarizes his theories, including his popular but complicated theory of reflexivity. Here is a first-person account of a brief conversation between Stanley Druckenmiller and George Soros right before they added immensely to their short position: