What Is George Soros' Reflexivity Method

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Today, let’s talk about Georges Soros and his reflexivity theory.

(And yes I’m aware of the controversy and theories around him politically, but let’s strip that aside and just focus on his trading.)

Background

Soros survived the Second World War, came from humble beginnings as a waiter, and then went on to become one of the most successful fund managers of our time, forming the Quantum Fund with Jim Rogers.

Historically, the Quantum Fund achieved an average annual return of about 30% from its inception in 1973 until 2011, when Soros decided to return outside investors’ money and convert his fund into a family office.

This extraordinary performance includes a remarkable year in 1992, when Soros famously bet against the British pound and reportedly made over $1 billion in profit. That year, the fund’s return was about 100%… yes 100%

Reflexivity

He spent a lot of time shaping his philosophy of the financial markets which he called “reflexivity“.

Soros applied reflexivity theory to the markets, arguing that market participants’ biases, misconceptions, and limitations can lead to exaggerated booms and busts.

Here are the main points:

1. Mutual Influence: Market values and investor perceptions influence each other in a mutual feedback loop.
2. Away from Equilibrium: Markets do not necessarily trend towards equilibrium but may move away from it due to these feedback loops.
3. Self-Reinforcing Cycles: Positive or negative market trends can become self-reinforcing, often leading to asset bubbles or crashes.

Alright, so what does that mean for a typical short-term trader?

• Be aware of market sentiment – It matters what the crowd thinks
• Identify potential feedback loops – The trend will go on much further than you expect
• Adopt a contrarian approach – Think what you need to see to fade the move
• Consider event-driven opportunities – Interest rate announcements and inflation are driving this market, so build your battle plan around that.

Many traders are successful because they think about the markets differently than the crowd.

That doesn’t mean you need to reinvent the wheel, but if you can observe the price action and crowd behaviour through a different lens, that puts you in a much better position to take advantage of the sentiment shift when it comes.