Reflexivity: What It Means For Retail Traders

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.

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!

By |2018-12-17T18:52:27+00:00December 10th, 2018|Philosophy|8 Comments

8 Comments

  1. okeke February 15, 2015 at 7:42 am - Reply

    Isn’t George Soros the trader they say made a billion dollars betting against the British Pound? Well I’ve never heard of the book until now. But Chris even if I one day come across the book, you’ve discouraged me from reading it; If the book was and still is too difficult for a seasoned trader like you to grasp, then how can fledgling aspiring traders who’re relatively new to forex like me understand it?
    But I like the “Bachelor in the bar seeking female companion” explanation of reflexivity. Next time I find myself in the midst of some honeys I’ll remember and apply the theory!

    • Chris February 15, 2015 at 7:48 am - Reply

      Haha, don’t let my shortcomings stop you from trying. Next time you’re near a library, check out the book!

  2. George February 15, 2015 at 11:08 am - Reply

    What I have learned is that wanting is an act of lack generating lack.So when trading, just apply a method that makes sense to you, and keep repeating that without any outcome expectation. Just focus on the fishing like Chris says, not the fish..just like in that bar, just be yourself and let the chemistry happen without trying to influence it. Each time you try, you mess up with the outcome, just stick to the part you can influence like being ultra selective with your setups rules and deciding or not to trade on margin (your leverage, which is the nr 1 killer in forex).
    I always enjoy your posts Chris!

    • javier March 4, 2015 at 11:18 am - Reply

      you said what i wanted to George! hahaha..and i concur with you totally on the pocess not the fish! Chris, i read this book I borrowed from the library 1 year plus ago and i couldnt understand it too… Appreciate your post explaining it with the bar analogy1 thank you Chris..”)

      • Chris Lee March 4, 2015 at 12:00 pm - Reply

        Glad to could be of help!

  3. Ivan Manolov February 19, 2015 at 11:55 am - Reply

    I totally agree with you Chris. First is the fundamental analysis because we always trade two economies. Then is sentiment for whom you writing now. Unfortunately, many young traders are attached to indicators that show them what to do. Generaly psychological mindset in forex trading that if someone or something tells you what to do is detrimental…

  4. Kevin (TDT) Harper March 12, 2015 at 4:52 am - Reply

    Hey there Chris
    Regarding Reflexivity are you describing part of the “Art” part of trading .. sensing whats happening / about to happen via price action and various candle / bar formations etc

    • Chris Lee March 12, 2015 at 8:26 am - Reply

      Hi Kevin,

      The main point about Reflexivity (for me) is that in trading, I have to take into account not just what the market is doing, but also how other groups of traders are likely to respond to it. It’s not so much about “trading the market”, as it is “trading the people who are watching the market”. I hope that makes sense.

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