Soros: Maverick Investor Riding the Reflexivity Wave

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As a forex trader, let’s delve into the world of George Soros. Technical analysts don’t consider Soros one of their own, while fundamental analysts find his investment philosophy—focused on psychology and philosophy—quite distinct from theirs. However, this uniqueness is precisely what defines a successful forex trader: the ability to think outside the box. Many mistakenly believe that Soros’s philosophical investment approach has nothing to do with Warren Buffett’s value investing. In reality, Soros’s mentor, Karl Popper, and Buffett’s mentor, Benjamin Graham, share a common thread.

Karl Popper believed that human cognitive abilities are inherently flawed, leading to irrational decision-making and behaviour. On the other hand, Graham considered humans fundamentally irrational, especially in the short term. He advocated for quantitative analysis and safety margins to mitigate risks arising from incomplete human cognition. Soros, in turn, asserts that “our understanding of the world is inherently incomplete; there is always a gap between participants’ perspectives, expectations, and the actual state of affairs.” In other words, no one possesses ultimate truth, and our understanding of the world is always partial. “History is shaped by participants’ errors, biases, and misunderstandings.” Consequently, markets driven by numerous participants’ biases are often erroneous. Markets are chaotic and devoid of rationality and order. Our views on the market are also prone to error; we must accept the market’s scrutiny.

George Soros is a natural master at identifying major market trends. He believes that social science differs fundamentally from natural science because participants’ thoughts influence events themselves. Participants’ thoughts and events are not independent; they interact and mutually determine outcomes. Specifically, “reflexivity has two meanings: current biases affect prices, and in certain situations, current biases impact fundamentals, which in turn, we need to beyond the charts, lead to further changes in market prices.”

Building upon Popper’s ideas, Soros contends that complete human cognition affects financial markets, and market movements, in turn, exacerbate psychological biases. This theory closely resembles Graham’s discussion of the relationship between investors and the market.

Moreover, Soros emphasizes that any self-reinforcing movement resulting from incompleteness eventually exhausts itself, leading to a return to equilibrium. Soros often acts when markets reach extreme points. For instance, in 1992, when the British pound was significantly overvalued, and in 1997, when the Thai baht faced a similar situation, Soros seized the opportunity. This approach aligns with Graham’s method, which Buffett exemplifies. Buffett consistently enters well-managed companies during crises when market reactions are excessive.

Both Soros and Graham share two key elements in their analytical frameworks: first, the interaction between market and human psychology causes asset prices to deviate from specific centres; second, spotting market reversals, market and human psychology interactions drive asset prices to extremes, leading to reversal points and subsequent price regression. Whether Buffett buys Coca-Cola at a low price or Soros shorts an overvalued pound, both recognize that the current situation has reached an extreme, and regression is inevitable.

From this perspective, Soros’s reflexivity theory and Graham’s discussion of market-investor interactions align remarkably well. Moreover, Soros’s trading methodology closely resembles that of a value investor. Value investors enter the market when prices significantly deviate from intrinsic value—just like Graham, Buffett, Peter Lynch, and Soros. The only difference is that Buffett uses terms like “equilibrium” or “trend centre” instead of “value.”

Soros’s narrow interpretation of reflexivity focuses on the interaction between market and investor psychology, which is not significantly different from value investors’ discourse. His theory can be directly applied to other areas, such as credit cycles. Graham’s and Buffett’s arguments about market-participant interactions can be extended to various domains.

The “Pygmalion effect” in psychology, also known as “self-fulfilling prophecy,” is familiar to many. It describes how an individual’s beliefs influence behaviour, leading to success. However, this effect cannot deviate indefinitely.

Whether it’s the reflexivity theory or Graham’s price-value relationship, both emphasize that asset prices tend to regress to their intrinsic value within visible timeframes. Whether Soros’s “speculation” or Graham’s investment, both are based on the conviction that regression will occur.

Popper’s insights led Soros to recognize the limitations of human cognition. In the process of understanding things, truth gradually approaches, but complete knowledge of truth remains elusive. Soros began his financial trading career with this idea. According to Soros, asset prices often deviate significantly from the value centre due to incomplete human cognition. These deviations further distort human understanding, eventually driving prices away from value. However, at a certain point, prices reverse—a critical threshold.

Soros believes that traditional economic theories focus only on equilibrium states, neglecting the transition from equilibrium to imbalance. He attributes this imbalance to incomplete human cognition. Simultaneously, price imbalances reinforce human cognitive biases. Use the moving average indicator to retrieve the deviation.

George Soros, the renowned hedge fund manager, has a unique investment philosophy. He’s a short-term speculator who places massive, highly leveraged bets on financial market movements. His global macro strategy involves making one-way bets on currency rates, commodities, stocks, bonds, and derivatives based on dynamic macroeconomic analysis. In simple terms, Soros predicts whether these investments will rise or fall.

What sets Soros apart is his concept of “reflexivity.” and his unyielding passion for trading. Unlike traditional equilibrium-based theories, where all information is known and factored into prices, Soros believes that market participants directly influence market fundamentals. Their irrational behaviour leads to booms and busts, creating investment opportunities. For instance, consider housing prices: easy loans lead to more borrowing, increased demand, and rising prices. This cycle spirals beyond economic fundamentals. Soros capitalizes on such imbalances.

He identifies critical points—often during extreme market imbalances—and employs a method known as “marginal intervention.” Just like Warren Buffett, Soros sometimes goes against the crowd. However, not all contrarian moves are profitable. Both Soros and Buffett recognize that prices ultimately regress toward their intrinsic value, even after deviations. Soros’s ability to spot these critical points allowed him to defeat the Bank of England and Thailand’s financial institutions.

In summary, Soros’s trading philosophy revolves around riding the reflexivity wave, recognizing cycles of deviation, and daring to act when markets are at their extremes. His approach echoes Buffett’s selective contrarianism, emphasizing calculated risk and potential reward.

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