The Alchemy of Finance: Reading the Mind of the Market

by George Soros

Critical Praise . . .

"The Alchemy joins Reminiscences of a Stock Operator as a timeless instructional guide of the marketplace." - Paul Tudor Jones from the Foreword

"An extraordinary . . . inside look into the decision-making process of the most successful money manager of our time. Fantastic."- The Wall Street Journal

"A breathtakingly brilliant book. Soros is one of the core of masters . . . who can actually begin to digest the astonishing complexity . . . of the game of finance in recent years."- Esquire

"A seminal investment book . . . it should be read, underlined, and thought about page-by-page, concept-by-idea. . . . He's the best pure investor ever . . . probably the finest analyst of the world in our time." - Barton M. Biggs, Morgan Stanley

George Soros is unquestionably the most powerful and profitable investor in the world today. Dubbed by BusinessWeek as "The Man Who Moves Markets," Soros has made a billion dollars going up against the British pound. Soros is not merely a man of finance, but a thinker to reckon with as well. Now, in The Alchemy of Finance, this extraordinary man reveals the investment strategies that have made him "a superstar among money managers" (The New York Times).

Genres: Finance, Economics, Business, Nonfiction, Money, Philosophy, Psychology

384 pages, Paperback

First published January 1, 1987

About the author

George Soros is a Hungarian-American financier, businessman and notable philanthropist focused on supporting liberal ideals and causes. He became known as "the Man Who Broke the Bank of England" after he made a reported $1 billion during the 1992 Black Wednesday UK currency crises. Soros correctly speculated that the British government would have to devalue the pound sterling.

Soros is Chairman of Soros Fund Management, LLC.
As one of history’s most successful financiers, his views on investing and economic issues are widely followed.

Reviews

[Mara · Rating 2 out of 5]

Let's not skirt around the issue here- this book loses about a bajillion points* for having a man in a suit with his arms folded on its cover.

What does having your arms folded on the cover of your book say?
Typically one of two things:
1. "I'm taking back my America one book at a time!"; or (and this one is more common)
2. ADVICE!! "I am about to give you lots and lots of advice that will solve all of your problems and/or make you rich and/or force you to acknowledge that you'll never be able to follow my advice and, thus, are a failure."

Don't believe me? I'll let this little array speak for itself.**



Spoiler alert! (but not really), looks like George Soros fell victim to some terrible advice in book coveriness, because The Alchemy of Finance doesn't tell you how to do squat (or take back America, or the night for that matter, but I digress). So, if you're hoping for a step-by-step breakdown of how to land yourself in the top 20 of the Forbes 400, walk away now.

Why read this book if it won't make me rich??
If you're really asking yourself that question, then the answer is probably don't bother. However, if you're like me, (in addition to being awesome) you'll swoon as soon as he drops Karl Popper's name in the first ten pages (you know, the whole understanding of the self presupposes objectivity thing).

If that doesn't do it for you, don't walk away just yet. What this book is really about is Soros' theory of reflexivity , in "the markets" and how the assumptions of traditional Economics have gotten things oh so wrong. It's much more philosophical than it is financial, and George Soros is a pretty smart dude.

Why alchemy?
Alchemy and science are not the same thing (duh). Science is about finding an underlying truth — scientific theories are supposed to be "universally valid". Soros' theories of the market, however, are not. Why not? Because (according to Soros) he has been more prone to "predictive failures" than not, which (and here's the alchemy part) doesn't mean he hasn't had financial gains.

Alchemy, unlike science, is about operational success . This is why Soros has been able to fail to predict things about the world, but still rake in big bucks. The Market operates as a product of social phenomena- it's not like nature, where "laws operate independently of what anybody thinks."

"This creates an opening for alchemy that was absent in the sphere of natural science. Operational success can be achieved without attaining scientific knowledge. By the same token, scientific method is rendered just as ineffectual in dealing with social events as alchemy was in altering the character of natural substances."

Anything else?
I'm no economist, but I do like to dabble in the study of decision making, cognition and human behavior and, turns out, those things are pretty darn interrelated. My point? I'm probably going to bungle any attempt at real explanation, so I'll just point out a few bits and pieces.

- Homo economicus He doesn't exist, get over it! Humans are not rational actors and, even if we were, no one actually has all the options laid before them.

- Stock prices are the reflection of some underlying reality there is no "essential price" toward which a stock will inherently trend and certainly no reality that exists independent of our perceptions.

- Stock prices are shaped by underlying trends and prevailing biases which are then either self-reinforcing or self-correcting. Sometimes events fail to occur because they were anticipated.

- I'll give you one more for fun (and also because it confuses me): the act of lending changes the value of collateral.

Why the low rating?
This book is old (I think it's my junior by only a few years). Soros brings up interesting ideas, but IMHO there are far more interesting books to be read on most of them (e.g. if you want to talk recursion, then Douglas Hofstadter's your man). Maybe someone more familiar with The Market than I would disagree, but it's my review, and he did fold his arms while wearing a suit on the cover.

___________________________________________
* I'm sorry, but I can't be more precise due to adjustments for inflation and ever fluctuating currency markets, so you'll just have to live with my rough estimate.
** No, I haven't read any of these books, but can you blame me?

[Riku Sayuj · Rating 4 out of 5]

Finally an expert who admits that he is shooting in the dark, mostly.

[Stirling Mortlock · Rating 5 out of 5]

This is a book I read and re-read on a regular basis.
Soros has the greatest track record of any money manager, ever. This should give anyone who is interested in managing money, or managing their own money, a reason to read the book in which he describes exactly how he has made his billions.
It surprises me how many people have read the book, and yet, so few put the actual theoretical framework to use. Despite Soros's introduction of the ideas of reflexivity in financial markets nearly 30 years ago, this type of thinking is almost absent from the investing community.
And yet, these types of special reflexive situations abound in today's market. I have personally taken advantage of several.
On the downside, I do not believe that Soros a great writer. He can make simple concepts almost incoherent by using complex vocabulary and odd phrasing. This may be why he failed to make much progress as a philosopher.
In addition, this book is not for beginners in finance and money managing. The book assumes basic knowledge of the stock market and currency market. It also assumes knowledge of affairs that were current in the 1980's, but are probably a little arcane to today's investors. I had to look up various references like the Plaza Accord, which Soros profited handsomely from in the later half of the book.
So, if you have a working knowledge of stocks, bonds, and currencies, and you are interested in managing money at some point in your life, then you must read this book. Without it, you might as well be trading blind.

[Ben Sutter · Rating 1 out of 5]

I slogged my way through the first 200 pages of this...but enough is enough.

What I learnt is:

1) George Soros took high risk, leveraged positions. He became very rich. He may well have been skillful. He might have just been lucky. The Alchemy of Finance has not assisted me in determining which is more probable.

2) If he was skillful at making money, he certainly isn't skillful at communicating his methods and strategy. This writing style is muddy, convoluted and the majority of the content is spent on describing market noise from specific time points in the 1980s. How any of this is to be applied to present/future scenarios is not covered at all in the first 200 pages of the book at any rate. The author himself seems to indicate at times that he is not really sure how to explain how he did it. It is like reading a poor quality financial newspaper from the 1980s - I'm just not interested!

3) The author emphasizes how his intense emotional involvement with his portfolio was a key to his success. For example, how when he got a sore back this "told" him it was time to transact, or how he got so wound up about certain positions he felt like he was going to have a heart attack. Not only does this appear on the surface to be an extremely reckless way to manage money, but the attempt this book makes in trying to explain an emotional approach just doesn't work for me.

4) Despite Soros being opposite in style to Buffett & co, one commonality of all seriously successful investors is again reinforced by this book - they all sacrificed everything else in their life to become financial "rock-stars". You gotta give 60, 70, 80 hours a week consistently year after year - this takes a toll on other aspects of your life.

Overall, the one quote that stuck with me is that given by his son on p. 37:

"My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking, Jesus Christ, at least half of this is bullshit."

I wanted to shake off that quote as I progressed through the book....but I couldn't...I ended up siding with Soros jnr.

[Trung Nguyen Dang · Rating 3 out of 5]

An one idea book: Reflexivity, the circular relationships between cause and effect that feed momentum. Simplistically speaking, it just means momentum will feed itself until it becomes very extreme then it will reverse to the other extreme.

[Amir Dov · Rating 3 out of 5]

The Alchemy of Finance provides a peek to the mind and thinking process of who is probably the most successful market speculator in history.

The book can be generally divided to two themes (although with no particular order, as the chapters are kind of mixed):

The first theme is Soros' concept of reflexivity - which includes the explanation of what's wrong with the current academic conception of economics / finance as a social science, and some theoretical background to his own perspective which regards finance as an 'Alchemy', not science. His theory and approach (and thinking process) are smart and persuasive and there are definitely some jewels embedded in the text. However the writing is a bit cumbersome, the text is very lengthy and sometimes boring, and the book in general is by no means an easy-read.

The 2nd theme is the actual "real-time experiment" as Soros calls it, in which Soros goes week-by-week detailing his trading activity, demonstrating how he's returning ~130% through his fund in a little more than a year (this happens between the summers of 1985 and 1986). As impressive as this is, it was very hard for me to learn anything from this real time experiment. What I did learn is the very simple notion that there are speculator who actually make money in the market in the longer-term (well, there's at least one).

I would suggest to anyone who wants to get familiar with Soros' work and wisdom to read 'Soros on Soros' - which is a more refined and easy way to get to know the man and his work. You know how for some bands you would recommend listening to every album (or specific ones), which with others the recommendation will be to just go for 'the best of'? I'll make this analogy here and say that 'Soros on Soros' is a very good 'best of', while the 'Alchemy of Finance' is an ok album.

I guess the exception is that if you're really into macro economics or involved in someway in Macro / Macro-Quant hedge fund - this is probably one of the best books on this topic.

[Agenor · Rating 5 out of 5]

It is a rare thing indeed that someone who has had extraordinary success in a field takes the time to set out how he views his field and the main drivers behind his success, even rarer in financial markets. And yet here is this rare gem of a book, available to all who can be bothered to read it.

This is not a get-rich-quick book, nor a step-by-step guide to Soros's decision making process. This is a book for those involved in financial markets, particularly those with a philosophical leaning. A reasonable level of comfort with financial instruments and international economics is assumed and it reads as if it is written by a speculator for a speculator. The book outlines Soros's theory of reflexivity, his view of markets through this lens and includes a trading diary in which he records his thought process and investment decisions in real time - an amazing resource.

My only regret is I didn't read this book 10 years ago.

[Matt Kelty · Rating 2 out of 5]

A very smart, successful man is now a billionaire, but in his heart would rather be a philosophy professor. He realizes, along with many other people, that feedback loops exist in financial markets. He calls said feedback loops "reflexivity" and writes 200 pages. It's actually kind of fun to read, but there isn't much meat beyond this one concept. If he was able to make his fortune solely through an edge based on identifying feedback loops, there is a better book to be written eventually.

[Chris · Rating 5 out of 5]

I enjoyed The Alchemy of Finance far more than I expected I would, which I attribute to the fact that it is more an ideas book than a guide to anything or a retelling of events. More accurately, one idea is presented - the theory of reflexivity. Reflexivity is defined as a mutually recursive relationship between two variables which dynamically influence each other. Of course, Soros is not the founder of the idea of mutual recursion and other authors such as Douglas Hofstadter have far more sophisticated analysis of recursion and related concepts. However, Soros applied the idea to financial markets which - I believe he asserts correctly asserts- is a rare context for this framework of thinking. An example of two-way relationship of reflexivity is as follows:
A bank loans a business money based on collateral, which denotes the creditworthiness of a debtor. Collateral could be the value of a property or a future stream of income. However, the very act of lending impacts the valuation of the collateral. The value of collateral depends on the value of capital borrowed (e.g. leverage can improve gains on future cashflows or precipitate losses) and the value of the amount borrowed depends on the value of collateral. Ad infinitum. The two variables act dynamically with each other as dependent variables.

Participants in the fields of finance and economics have a fixation on theories explaining static states; equilibriums and efficient markets. Reflexivity suggests a permanent dynamism which follows what Soros terms a prevailing bias, with no single equilibrium tended to. The reflexive relationship promotes boom / bust cycles due to the self-reinforcing and self-correcting nature of mutual recursion. Expansion of credit leads to inflated values in assets, which are in turn used as collateral for further credit expansion. As Soros notes, economic contractions happen more rapidly as a tipping point is reached and market participants rush to liquidate deflating assets. Precipitous falls in market value are often the result of unexpected events, and the forecasting of known-known decreases can reflexively prevent them eventuating. Soros's conclusion is that the knot of recursion from reflexivity in all financial varieties (e.g. lender to debtor) is too challenging to untangle and the scientific method cannot be applied. Hence, the term alchemy, which refers to the achieving of operational success without a formal system which verifies a truth.

One gets the impression that Soros would trade all his wealth for an esteemed place in the world of philosophy. Soros was a student of Karl Popper, which explains his fascination with the scientific method. As well as making a fortune speculating on financial markets, Soros took years off to write a philosophical text. An interesting comment he makes is that the abstractions of philosophy and the scientific method distanced him from his 'reality' trading where he believes overarching theories do not apply and instinct rules. He claims that returning from the abstract world of philosophy made him less profitable.

For a blood-thirsty capitalist, Soros is also surprisingly astute in his comments on the limitations of capitalism; "Yet it is easy to exaggerate the merits of having an objective criterion at our disposal. We have become so fixated on objective criteria that we are inclined to endow them with a value they do not intrinsically possess. Profit-the bottom line-efficiency- takes on the aspect of an end in itself, instead of being a means to an end. We tend to measure every activity by the amount of money it brings... Values that motivate people cannot be readily translated into objective terms; and exactly because individual values are so confusing, we have elevated profit and material wealth-which can be readily measured in terms of money-into some kind of supreme value. "

The Alchemy of Finance is a bit of a one trick pony admittedly - the central idea being the theory of reflexivity. However, the book essentially felt like a formal exposition and shaping of existing personal thoughts. I listened to the audiobook and the writing style translated well.

5 stars.

[cfog · Rating 5 out of 5]

Short review: Hard work, but deep. A better title would be "The Alchemy of How Everything Works".

Long review:
Nominally, “The Alchemy of Finance” is about understanding markets and making better investing decisions. If that is all one learned it would be a crying shame, because the book is actually about understanding reality and making better decisions. To restrict it to the markets is a serious mistake and not one Soros makes.

One of the most important steps to understanding reality is understanding the feedback loops that operate. These can be self-sustaining for some time and often lead to exponential change, but are ultimately, necessarily, self-defeating. A fission bomb is one example. A Uranium atom splits and releases two neutrons. Each of those can cause another atom to split. An enormous amount of energy is released, but quickly there will be no more Uranium left to split and the chain reaction will end.

The same mechanism underpins financial markets, leading to booms and busts. Considering the dynamic created by feedback loops is important when making almost any kind of decision, as is its implication: Complex systems (markets, diplomacy, reality) are historic processes which can be uniquely explained post facto but which have many possible outcomes ex ante.

Building on this, “reflexivity” is the term Soros uses to describe the feedback loop which runs between reality and the participants’ understanding of reality, and vice versa. Traditionally, we think only of the causal arrow from reality to our thinking. FooCorp has grown its market share by 25%, therefore we think it is better than its competitors. Reflexively, the arrow also runs the other way. For whatever reason, the bank thinkg FooCorp is better than its competitors so they loan them money. As a result, FooCorp becomes more competitive. Reflexivity occurs in economics, politics, dyadic interpersonal relationships and drives the Jobsian “reality dysfunction field”.

Economic supply and demand curves are an interesting example of reflexivity. Typically, they are independently given and assumed not to interact. Instead, their intersection should simply determine the price at which the market clears. However, trivial examples of reflexive interaction between the two abound. High supply versus demand in a commodity (and therefore low prices) stimulate new and innnovative uses for it, in turn creating new demand. Higher demand increases prices, which in turn increases supply. Prices do not stay at equilibrium but instead move dynamically, in a historic process.

Reflexivity also introduces unpredictability into the historic process that is reality. In part this is beacause participants are seeking to understand reality but also affect reality. These goals can conflict with each other. Additionally, what needs to be a fact to make prediction possible is itself contingent on participants’ view of the situation, an unknowable which changes if it is learned. Whether or not Bob Smith stands for leadership of the Bar Party depends on what he thinks everyone else thinks about his standing for leadership.

What does this mean for the existential goal that is predicting the future? On the one hand, acknowledging reflexivity and its implications forces us to acknowledge that perfect prediction is impossible. On the other hand, perfect prediction is not necessary and incorporating it in our analysis allows us to do better. Classically, participants’ opinions are not causally potent, first class citizens in any model. They are statements about the model, not facts in the model. By explicitly including them we gain greater predictive power. That is what we can do. How? That depends.

[Mike · Rating 5 out of 5]

Concise thesis that the basic concepts on market supply and demand I was taught in MBA and CFA programs is so significantly flawed by assumptions of independence and inertness as to heavily question the model's value. Since that is the basis for most economic theory its a pretty big challenge. Since over a long career, Soros was able to trade on his theory and consistently out perform the market, it obviously should be considered.

Take always:
1. Market trends are long and wave form.
2. Collapses are often avoided by the nature of predicting their appearance and the market adjusting.
3. Collapses usually happen due to unexpected events.
4. Trends either direction are self reinforcing, and thus will continue past the point of rationality.
5. Because of 4, being contrarian is inherently a losing bet unless you can time inflection points, which is very very difficult.
6. The key point is a concept of reflexivity where the market trend affects the underlying value, which affects the trend, usually in a positive way, which affects the value, and so on. This continues until the trend is far out of whack with fundamentals which will cause a sharp correction and start of a new trend line, often in the opposite direction.

[Jim · Rating 3 out of 5]

One of the greatest traders and greatest minds of our lifetime. It doesn't get a higher rating because the communication of his ideas of social science/philosophy/principal of reflexivity etc are a little hard to follow at times. I would say that was just me but almost everyone I know who has bought this book hasn't finished it.

[InvestingByTheBooks.com · Rating 5 out of 5]

This book is by many famous traders quoted as the revelation that changed how they view markets. Not that the author needs the validation of others. “Four hundred seventy-three million to one. Those are the odds against George Soros compiling the investment record he did [...]” as Paul Tudor Jones II states in his foreword. In The Alchemy of Finance Soros presents his theory of how markets work, a theory he has named reflexivity.

The philosopher, science theorist and originator of the black swan example, Karl Popper was also the teacher of George Soros. According to Poppers method of empirical falsification knowledge cannot be proven truths. What we call knowledge are theses that have been subject to critical examination and have not yet been proven false. It doesn’t mean they are true but they are the closest we get. This view also forms the core of Soros theory of market functionality. The market also forms a hypothesis and puts it to the test during the actual course of events.

The first part of the book is a critique of the so called modern portfolio theory but also above all a presentation of the reflexivity theory. With market prices as the intermediate, the thinking actor’s imperfect perception influences reality just as reality influences perceptions. There is a two way interaction, not only between market prices and investor perceptions, but also between market prices and fundamental economic developments. The feedback in these processes ensures that the system cannot be in equilibrium. For example, expectations on a situation simply cannot be stable if the expectations in themselves affect reality. Instead the interactions create loops that, at times, bring market prices far from rationality.

Human perception of a situation will according to Soros always be faulty. As no one can know how others view a situation and the collective view will affect the situation, everybody will have imperfect information. The errors will either be too optimistic or pessimistic, but the net balance will constitute what Soros calls the prevailing bias. Changes in prevailing bias change market prices. In extreme situations the loops between market prices, the reality and the prevailing bias will create booms and busts. Understand the process, spot the miss pricing plus the trigger that will break the feedback loop (plus preferably the timing of the trigger) and you will be able to act faster and invest with greater conviction than other market participants.

In the major part of the book Soros goes through a number of macroeconomic situations of the 1980’s, using the reflexivity model as the analytical tool for these case studies. After this experiment is evaluated the author finally makes a number of prescriptions for how economic policy should be conducted. The combination of theory formulations, reviews of passed economic situations and a Hungarian born author with a language that is complex and a tone that is slightly overbearing, is sure to weed out those not truly interested in the topic.

This doesn’t make the book less important. At the time overlaying Karl Poppers thinking on financial markets was a true revolution. However, few practitioners and academics understood the message and Soros never became the renowned philosopher of the markets that was so clearly his ambition. Many of those who took his theory to hart were neverthelsess immensely successful and today the influence that theories around complex adaptive system are starting to have suggests that Soros was simply way ahead of his time.

The book is in no way a pleasure to read but if you haven’t read it you don’t fully understand how markets work.

[Gabriel Pinkus]

This book, much like John Burr Williams' Theory of Investment Value could be shortened immensely for the big idea one ought to take away - The Theory of Reflexivity

Soros' Theory of Reflexivity is a rational explanation of why economics is so terrible (read: absolutely awful) predictor of the future, and why social sciences as a whole tend to fall so short of natural sciences. Economists tend to get "physics envy". When you have thinking participants, results change. In physics, gravity pulls you to the ground regardless of whether or not Newton writes about it. However, what if Newton's writings changed gravity? Huh?

RG Collingwood wrote a long time ago about how Europeans made fun of native warrior dances and being nonsensical to them and therefore illogical. Collingwood wrote that when a warrior believes those dances help make him a better warrior, he becomes more confident and therefore a better warrior. When an enemy sees him do the dance and yell loudly, the enemy becomes more frightened and at a disadvantage - the belief made it real.

George applies this idea to social science and finance. Alchemy doesn't work, but by believing it works, people can achieve "operational success" as alchemists. I am very surprised Soros' idea has not been taken more seriously or taught in schools.

If people's opinions are a function of results, and results are a function of people's opinions, you get this chaotic, nonsensical, random, all-over-the-place reality. There are instances where the two are functions of one another. It's like Y = f(x) and X = f(y). Just because you can't graph it doesn't mean it doesn't happen in real life.

[Nathan]

The Alchemy of Finance helps establish a modal of thought for the market and economy. It debunks the myth of efficient market theory where everything is ‘priced properly.’ Instead it posits how humans are not rational actors in a system. This inherently leads to a dynamic adjustment (volatility) in an illogical way. Trends will favour prevailing biases of the time. This can in part lead to speculative bubbles. The longer these bias trends go on for, the longer the boom. At inflection points these trends reverse and create busts.
These inflection points can be determined by a credit cycle. Low interest rates (which allows people to easily borrow money creates an acceleration of buying). Then when insolvency hits an increasing of interest rates lower buying which then pops these bubbles of prevailing bias.

That being said I disagree with his dissent from a contrarian and fundamental approach applied by Benjamin Graham, Warren Buffett, and Carl Icahn. It is a simpler way to understand values in the economy. In a context of investing, you want to buy assets that have a lower market value than intrinsic value (working capital, book value, equity and assets), and to also factor in growth. This will give you a valuation of a business which is either higher than the market price or lower. Regardless of the prevailing biases these businesses will always have to revert to the mean in due time. Through this modal you can understand inflection points of any business at any time in the economic cycle.

I would recommend reading The Intelligent Investor preceding and then The Alchemy of Finance. One can garner a lot from this book and get into the mindset of a great investor!

[George Jankovic · Rating 5 out of 5]

A book by one of the 2-3 greatest investors of all time. It's about his reflexivity theory: stock prices are influenced by the economy then they, in turn, influence the real economy. And how all that applies to investing.

[Matt · Rating 3 out of 5]

I think you can get by reading the Introduction and Ch 1 and skipping the rest of the book, which felt like a series of ramblings

[Sjors · Rating 1 out of 5]

Just wrote a pretty long review, then my phone dumped it. The long and short of it was that this book contains no actionable insights for me. The philosophical part is interesting but floats without ever touching the ground. The practical part, an investing diary from 1985 to 1986, deals with market circumstances so old that the blow-by-blow treatment offered is not very useful. It would have been more useful to treat each of the trade categories (debt, commodities, stock, etc) in turn and coherently discuss how the market behavior was foreseen and capitalized upon. As it stands, this diary provides me with little insight.

I rate non-fiction books according to their usefulness to me, at the moment in time I read them. This book may be great for someone else, but not for me.

[Andreas Lorenz · Rating 5 out of 5]

The most important concept in this book is "reflexesivity" - a novel concept in economics according to GS. It is basically a merger of the in "second order chaos theory" and that the "arrows of causation" runs both ways in any system. This means that the idea of equilibrium is an abstract/deduction with very little real word consequences in most financial markets.

This is highly recomendable as it basically says that all our standard models of economics are - if not wrong - then without much real life consequence.

Note: This is NOT a guidebook on how to become rich. Rather: GS uses his insights from finance to form a theory of the world.

[Vaishali · Rating 3 out of 5]

Dry, and far more nonlinear than expected. Prepare yourself to repeat sentences; Soros writes like an academic, and even alludes to this once. The one concept he hammers in more than any other : markets do & will fluctuate.

Some rare brass tacks :
-----------------------------

"I react to events in the marketplace as an animal reacts to events in the jungle... for instance I used to be able to anticipate an impending disaster because it manifested itself in the form of a backache."

"If we want to understand the real world, we must divert our gaze from a hypothetical final outcome, and concentrate our attention on the process of change that we can observe all around us. This will require a radical shift in our thinking."

"Since the bias is inherent, the unbiased is unattainable."

"Existing theories about the behavior of stock prices are remarkably inadequate. They are of so little value to the practitioner that I am not even fully familiar with them. The fact that I could get by without them speaks for itself."

"Full employment is a special case."

"The stock market comes as close to meeting the criteria of perfect competition as any market: a central marketplace, homogenous products, low transactions & transportation costs, instant communication, a large enough crowd of participants to ensure that no individual can influence market prices in the ordinary course of events, and special rules for insider transactions as well as special safeguards to provide all participants with access to relevant information. What more can one ask for?"

[Luka · Rating 4 out of 5]

Heisenberg's principle is that mass and velocity of quant particle can not be measured at the same time because the act of measuring affects the object being measred.
Are those methods appliable for natural and social criteria, too?

[Asif · Rating 3 out of 5]

Interested read. Found myself agreeing to the concept of changing equilibrium and two way causality (reflexiveness) but also disagreeing with some of his views.

[Justin · Rating 3 out of 5]

A bit old and not too actionable

[Tim Jaeger · Rating 2 out of 5]

The concept of reflexivity and the trading journals were interesting. Otherwise, it was a slog.

[Gabriel Rondelli · Rating 5 out of 5]

George Soros is indeed an intelectual and this book is undoubtly in the "heavy weight" rank.
Curious, I seem to favour such books recently, in detriment of my reading goals, but I digress, this was worth it.

The book is a mix of a personal journal and a philosophical essay on the Theory of Reflexivity.
At the time the book was written, Soros's practical experience was mirroring the findings of Kahneman and Tversky on the irrational behavior and cognitive biases in decision-making. Later, these findings were taken from the individual level and applied collectively to explain market movements and forming of speculative bubbles.
It is very interesting to see how Soros concomitently reached the same conclusions as others have in the academic circle, but in his case, as a market participant, thus arriving at the same point from personal experience and heavily influenced by the works of Karl Popper.

The meat of the book is his personal experiment, where for a specific time-frame, he detailed and presented the thought-process of his decision making with practical examples.
This book is not for the faint-hearted and knowledge of financial instruments and macro-economy, together with other readings, such as the works of Karl Popper, are required to get the most out of this book.

In the end, Soros in his experiment, suffered from his own self-fulfilling prophecy, as a market participant he influenced the market, thus the market took that into consideration and adapted to eventually render Soros's predictions (some) irelevant.

Some will say folly, Kahneman will say hindsight bias, I say that Soros by eliciting his Reflexivity theory first, before the experiment, proved a point: that we can only look at the market as a historical process.

[Ramesh Ruthrasekar · Rating 5 out of 5]

Whatever it is, he was most likely on drugs when he conceptialized this idea! If fundamental analysis is based on eps, he questions which underlying trends are influencing eps and in turn, by positive reinforcement how high eps can make or break a trend - reflexivity!

Technical analysis is primitive, fundamental analysis can be flawed and in comes reflexivity. He points out innumerable instances on where he made money by expecting reflexivity, but hardly demonstrates on how we as readers can use it. Many macro economic observations were awesome

[Geoff Steele · Rating 2 out of 5]

discusses how market participants end up affecting the prices, economies, trends, boom & busts, or in other words the market itself. Much like perception is reality...but in this case, perception really does affect asset prices, loan valuations, collateral, currency exchange rates. etc. and thus the market is reflexive to these activities. Interesting stuff, kinda like quantum physics in that the act of observing affects the object observed.

[Stefan Bruun · Rating 4 out of 5]

A dynamic alternative to the classical models of macro economics. It is clear that the dynamic/reflexive model is of more relevance to investors than the classical static ones. A lot of overlaps with Soros on Soros, though both more practical and more philosophical.

[S · Rating 3 out of 5]

Takeaways

Billionaire George Soros says markets do not tend toward equilibrium and certainty.
He supports the concept of reflexivity, which says that what participants think of a situation will change that situation.
Participants’ expectations shape market facts, which, in turn, shape participants’ expectations.
This constant cycle makes market equilibrium impossible.
Because humans are uncertain, fallible and self-reinforcing, so are the markets.
The theory of efficient markets and rational expectations imply that markets will optimally allocate resources. This is false.
Fundamentalists say markets are a force for moral good, but they are not.
Regulation may have been excessive in the second half of the 20th century, but deregulation seems excessive now.
The international financial system keeps central wealthy countries rich and in power.
History does not move from outcome to outcome, but from expectation to outcome to expectation.

Summary

The Power of Perceptions

George Soros once told a Princeton University seminar on international finance that the economic notion of equilibrium is irrelevant to financial markets and pernicious to traders. Because traders profit when they follow trends – that is, they make money when they correctly anticipate the expectations of market participants – perceptions actually drive markets, and fundamentals do not. Trends occur because perceptions reinforce themselves until some shock sends expectations in another direction.

The markets provide a merciless reality check.
The seminar’s host professor, former U.S. Federal Reserve Chair Paul Volcker, reports that Soros struck a successful blow against rational expectations, efficient markets and other notions from the economics textbooks. Soros explained that a stable state of equilibrium can’t exist because changing expectations constantly shape and reshape the market. Volcker finds that Soros’s distinctive perspective and his sense of how finance really works had important implications for both policymakers and academics.

Economics and Reflexivity

Soros is a proponent of the concept of reflexivity, which observes that what participants think about a situation influences the situation – and the situation shapes the participants’ thinking. Their understanding is always flawed because the reality they are trying to understand is not constant. Statements they make about facts can change the facts, as can the actions they undertake. This means that people really can’t know their situations, because those situations are contingent on what people know about them.

Markets cannot and will not arrive at a stable equilibrium precisely because the thoughts and therefore the actions of market participants will affect market behavior: The market will in turn influence the ‘fundamentals’ and shape new expectations in the continuing reflexive process.” [ – Paul A. Volcker, foreword]
The most widely accepted economic model in contemporary finance, the theory of rational expectations, suggests that current expectations provide a full picture of future events. It says that market prices are efficient, which means that they incorporate and express the aggregate effect of all available information. This theory suggests that financial markets will move toward equilibrium based on participants’ expectations unless some external shock introduces new information. Taken together, efficient markets and rational expectations imply that markets will optimally allocate resources. However, considerable evidence indicates that this is false.

The concept of reflexivity is very simple. In situations that have thinking participants, there is a two-way interaction between the participants’ thinking and the situation in which they participate.
The rational expectations theory is flawed because it postulates that market actors pursue their own best interests. However, in fact, they do not make decisions based on what is really in their best interests, but only on what they think is in their best interests. They have an imperfect understanding, so unintended consequences follow almost any decision. Therefore, they often make decisions that turn out not to be in their best interests, even though they thought they would be.

Bias prevailing in the financial markets can affect the so-called fundamentals that markets are supposed to reflect.
Rational expectations theory suggests that while any individual may be fallible, the overall market – because it subsumes all individuals – is much wiser than any individual. Yet, the market’s collective opinion rests on self-reinforcement. Speculators expect prices to rise, so they try to buy low now to make a profit later. Their buying pushes prices up, so it appears as if their expectation of rising prices was correct. This self-reinforcing process continues until the market can no longer sustain it. Markets are usually wrong, but they look right because of self-reinforcement. The incorrectness of this bias is exposed at inflection points, where expectations change – but only at inflection points. Bubbles are only one example of reflexivity in action.

The “Human Uncertainty Principle”

The human uncertainty principle is something like physics’ “Heisenberg uncertainty principle,” but humans are more uncertain than physical particles. Immutable laws of science do not change because of what people think of them. Human reality is different. Human beings actually create their social reality based on their understanding. People make decisions grounded on what they believe and expect, not on what they know with certainty, because there can be no certainty. Since no decision is really based on knowledge, people decide and act in a sort of fantasy world. Therefore, the results of their actions are likely to be something other than what they expect.

Power Relationships

Power relationships and political events seriously curtail the ability of market participants to make free exchanges. The world financial system has two types of countries: those in the center and those on the periphery. International debts are denominated in the currencies of the center countries. Therefore, these nations can borrow in their own currencies, but peripheral countries cannot. This gives the center countries the liberty to use countercyclical fiscal and monetary policies to keep their economies strong, for example, applying financial stimulus rulings when recessions loom.

Only when the fundamentals are affected does reflexivity become significant enough to influence the course of events.
Countries at the periphery do not have this power, because they have borrowed in foreign currencies. Thus, they must subject themselves to the discipline of international lenders, such as the International Monetary Fund, which defends this system and the interests of the center countries. If the price of protecting international lenders is recession in peripheral countries, the lenders are willing to pay it. Of course, they aren’t really the ones who pay.

The ‘human uncertainty principle’...holds that people’s understanding of the world in which they live cannot correspond to the facts and be complete and coherent at the same time.
Financial globalization is but one item on the agenda of market fundamentalists. Governments no longer have the power to control the movement of capital, which goes quickly and easily to whatever venues offer the best-expected returns. Market fundamentalists have been remarkably successful in reducing taxes, deregulating and spurring one of history’s longest bull markets. The United States and the United Kingdom profited immensely by acting as bankers to the world and as investment destinations for global savings. The heavily indebted countries of the periphery paid a steep, painful price.

Participants are not in a position to prevent a boom...even if they recognize that it is bound to lead to a bust. That is true of all boom/bust sequences. Abstaining altogether is neither possible nor advisable.
Market fundamentalists claim that markets are forces for moral good because, they contend, the most hard-working, innovative people win. Of course, this argument is flawed because market participants begin at different starting places with different endowments. The hardest working, most original people do not necessarily win at all. Instead of allowing everyone to compete freely and willingly, markets merely serve to keep the powerful on top.

A Real World Test

Soros tested his theories of reflexivity and uncertainty in 1985 and 1986. His son told a biographer that as a child he thought his father’s economic theories were hogwash: “The reason why he changes his position on the market or whatever is because his back starts killing him.” Soros acknowledges that previously backaches have warned him of portfolio problems. His awareness of uncertainty and reflexivity made him pay attention to this physical warning of tension and trouble. As he explains, “I used to treat the backache as a warning sign that something was wrong in the portfolio...When I finally discovered what was wrong, it usually went away.”

Most of the misdeeds of the recent boom fall into two categories: a decline in professional standards and a dramatic rise in conflicts of interest.
Believing that all investment theses are flawed, Soros is always alert to the possibility that any investor can make mistakes. He remains tuned into the reality that decisions usually have unexpected, unintended results. Financial markets often support delusions and deceptions, as in booms and busts, and even successful outcomes do not prove any given hypothesis. Knowing all that, Soros felt his backache was a danger signal he could not ignore.

Both are really symptoms of...the glorification of financial gain irrespective of how it is achieved.
He experimented with his concepts in phases. In phase one, from August to December 1985, he had remarkable trading success. Shares in his Quantum Fund rose 126% while the S&P gained 27%. After a control period from January to July 1986, Soros embarked on his second phase from July to November 1986. In this phase, Quantum lost 2%, while the S&P rose 2%. Soros’ major error was failing to exit the stock market, especially in Japan.

Investors had come to value growth in per-share earnings and failed to discriminate about the way the earnings growth was accomplished.
Market events in the two phases differed so radically that Soros had to rewrite his evaluation of the first phase in light of subsequent events. He found that his predictions of real-world events were generally unreliable. Why? Market success does not depend on the ability to predict what will actually happen in the world, but on the ability to anticipate what people will expect.

The financial markets are very unkind to the ego: Those who have illusions about themselves have to pay a heavy price in the literal sense.
Soros’s success in predicting the markets was greater than his success in predicting reality. In the financial markets, a good outcome is not defined as finding the truth, but rather as making a profit. The two are not necessarily related. Moreover, the market’s expectations of real world events may have changed those events. For example, expectations that the banking system would collapse led to action by financial regulators, which affected the outcome.

What Is to Be Done

The theory of market equilibrium underpins participants’ faith that the markets will allocate resources in an optimum way. But if the markets do not seek equilibrium, no reason remains to suppose that their results will be optimal. In fact, markets do not move toward equilibrium – reflexivity and human uncertainty ensure that equilibrium is unachievable.

Financial success depends on the ability to anticipate prevailing expectations and not real-world developments.
The ideas of market fundamentalism swayed many people in the financial world. However, although market results are objective, measurable facts, they are not “true” because – given the lack of equilibrium – they are never stable. The fact that people now measure the quality of an artist based on the price paid for the artist’s work, not on its artistry or merit, indicates how far market fundamentalism has gone. Moreover, any values that the market cannot measure seem incomprehensible to the fundamentalists.

I have never been good at math.
Markets tend to instability – not equilibrium – because of reflexivity and uncertainty, the boom-and-bust process, and other elements. Markets are unstable and are growing more unstable. Regulation may have been excessive in the second half of the 20th century, but deregulation seems excessive now. The world may need an international central bank and an international currency linked to oil. Markets are not a force for moral good – they are amoral. To the extent that society values stability and moral good, it must bring these values back to the market process with appropriate institutions and regulations.

Changes of Mind

Given time and new information, Soros changed his thinking about some of the ideas he included in earlier editions of Alchemy of Finance. The original chapters, which remain in the new edition to preserve the historical record, repeat his former theories, but he further clarifies some concepts in new material. For instance, he notes that the 1980s wave of mergers among American corporations did not, as he had predicted, turn out to be a boom-and-bust cycle on the order of the conglomerate wave of the 1960s.

He reports that in the previous edition he overemphasized the boom-and-bust model. Some self-reinforcing processes do not work out as booms or busts. For example, Ronald Reagan built his early 1980s monetary policy on currency strength, and budget and trade deficits. Economic theory stipulates that a trade deficit causes a currency to weaken and causes domestic economic activity to fall. However, Reagan’s budget deficits stimulated economic activity and his high interest rates brought in enough capital to outweigh the trade deficit. This self-reinforcing process was not a boom and bust.

Soros now explains that causality does not move historically from outcome to outcome, but from expectation to outcome to expectation. He refers to the outcome-to-outcome construct as his “shoelace theory of history,” where a cause-and-effect cycle evenly connects two sides. However, this metaphor mistakenly implies symmetry between expectations and outcomes. Actual outcomes seal the past, including past expectations, but the future remains open. This is the “Zip-Loc theory,” which likens history to a sealable plastic bag. “Needless to say,” Soros says, “neither theory claims that history can ever be fully known.” And he adds that even “Calling them theories is an exaggeration.”

[Terry · Rating 4 out of 5]

The idea of reflexivity is interesting, can be widely applied to many social/economic activities. The normality of the market is not stability, but from one extreme to another. I agree with it - reflexivity drives sentiment, stock prices drive fundamentals too. Especially in fixed income, rising asset prices drive up value of collaterals, and therefore risk tolerance of banks, and more lending means better economic activities and more borrowing. The reverse is also true. This is why momentum works.

The middle part of the book is Soros’ real time experiment of his theory. When I read it, I just feel how hard it is to trade macro. To be honest, I don’t fully understand how he makes every macro trading decisions based on reflexivity. I don’t see the connections. He sometimes has a view on JPY, treasuries, equities, but the reasoning of the view depends on his interpretation of an event. And I notice these views are quite random, even for Soros. I don’t know how to systematically implement such investment strategy. On contrary, Ray Dalio’s book is more executable.