George Soros is one of the richest traders in the world… which is why many years ago, I tried to read his book The Alchemy of Finance.
I said I tried because as a young trader I could barely understand it. Even today I’m not sure that I do. (It’s not an easy book to wrap your head around!)
Thankfully though, I didn’t walk away from it empty handed.
I managed to learn from it one of the most influential concepts of my trading career: Reflexivity.
What is Reflexivity?
Reflexivity describes a situation whereby the outcome of an event is influenced by its observers, which then results in a feedback loop.
Here’s what it means in practical terms:
Imagine a 28-year old bachelor at a swanky bar in town.
He’s sitting alone and would like some female company. He’s looking for intelligent conversation, and, if there’s chemistry, perhaps some harmless flirting.
He looks around and sees a room full of attractive women. For the moment, he’s thinking of himself as an observer.
What he doesn’t realize though, is that the women in the room are also observing him.
They’re looking at how he carries himself, his posture, the type of drink he orders.
If he seems confident, warm and approachable, the women would respond with favorable body language. They’d steal glances at him, smile, and perhaps even give him a wink.
If however, he behaves like a creep who just sits in a corner staring at women all night, all he’ll get is a room full of cold shoulders.
As an uninformed observer, he might be thinking either:
- “Wow, I’m on fire tonight!”; or
- “Women don’t seem to like me at all…”
You see, what this man doesn’t realize is that he is influencing the outcome of his observations.
The manner in which he carries himself changes the way the women behave towards him, which in turn affects his confidence and how he carries himself (see the feedback loop here?).
This, in a nutshell, is what Reflexivity is about.
Reflexivity In Trading
The theory of Reflexivity is one way George Soros describes financial markets.
When traders and investors see the market price going up, many are lulled into becoming buyers themselves, which in turn pushes the market price further up, thereby attracting more people to join in, creating a self-reinforcing cycle.
How Reflexivity Changed My Trading
Before learning about Reflexivity, I had previously learned how to trade from a “professional expert”.
The trading seminar set me back $3,000 and was basically just about technical analysis applied with the benefit of hindsight.
But the theory of Reflexivity taught me that there was more to trading than following a bunch of arbitrary technical indicators and support/resistance lines.
I learned that embedded within market prices are traders’ thoughts and expectations.
So from then on, my trading became less about following technical indicators and more about understanding what traders are expecting, thinking and feeling.
Occasionally, there’s a gap between what the market thinks and the fundamental reality… and that’s when I enter my trades.
(This is, by the way, how the Icarus method works.)
The theory of Reflexivity taught me that technical analysis should not be the primary consideration in trading.
The more important thing is to understand what’s happening in the market and how people think and respond to it.
That’s where the best trading opportunities are found.
So Have You Read The Alchemy Of Finance?
And did you manage to finish the book?
What do you think about the theory of Reflexivity?
Let me know in the comments below!