Predicting Stock Market Swings for Profit
George Soros is a billionaire investor that’s famous for breaking the Bank of England back in September of 1992, when he risked $10 billion on a single currency speculation that generated a $1 billion profit in a single day. In addition to the historic trade, Mr. Soros ran the Quantum Fund that returned more than 30% per year while he was at the helm, in part by predicting the Asian financial crisis in 1997 with a well-timed bet against the Thai baht.
In this article, we’ll take a look at a core tenant of Soros’ widely successful investment themes – reflexivity – and how international investors can take advantage of the concept.
Reflexivity is a framework that refers to the circular relationships between cause and effect – that is, the self-reinforcing nature of market sentiment. For example, rising prices tend to attract more buyers who drive prices even higher until the feedback loop becomes unsustainable, causing the same process to occur on the way back down. These self-reinforcing feedback loops lead to more disequilibrium than equilibrium.
According to Mr. Soros in a BuzzFlash interview circa 2004:
The concepts of reflexivity differ from the equilibrium theory that permeates popular economic theories.
While equilibrium theory suggests long-run prices trend towards underlying fundamentals, reflexivity posits that self-reinforcing markets tend towards disequilibrium, which creates potential opportunities to profit. These tendencies ultimately cause the boom-bust cycles that shouldn’t necessarily occur under traditional economics.
George Soros made the majority of his money by predicting bubbles in international markets around the world using his reflexivity principles as a guiding light. Rather than trending towards an equilibrium, he believes that the financial markets perform in line with the biased expectations of the participants. Spotting the divergence of these biases from reality can highlight potential investment opportunities as a contrarian or trend follower.
For instance, the rise of conglomerates in the 1970s came about because price-earnings multiples were increasing faster than other areas of the economy. Conglomerates eventually overextended themselves and suffered major losses, but nobody really stepped back and took time to analyze why conglomerates were being formed at the beginning – they just jumped on the trend and the price earnings multiples simply kept rising.
Soros also believes that regulators tend to be behind the private sector in terms of regulating these bubbles, which means that these opportunities continue to exist and will probably continue to persist over the coming years.
International investors looking to learn more about these concepts can read George Soros’ book on the subject, called The Alchemy of Finance, or his many essays that have been published across several different financial publications.
In addition, those interested in following Mr. Soros’ trades can do so by looking at his 13F-HR SEC filings where he’s required to disclose certain positions in his portfolio.
In this article, we’ll take a look at a core tenant of Soros’ widely successful investment themes – reflexivity – and how international investors can take advantage of the concept.
What is Reflexivity?
Reflexivity is a framework that refers to the circular relationships between cause and effect – that is, the self-reinforcing nature of market sentiment. For example, rising prices tend to attract more buyers who drive prices even higher until the feedback loop becomes unsustainable, causing the same process to occur on the way back down. These self-reinforcing feedback loops lead to more disequilibrium than equilibrium.
According to Mr. Soros in a BuzzFlash interview circa 2004:
“Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception. Every bubble consists of a trend that can be observed in the real world and a misconception related to that trend. The two elements interact with each other in a reflexive manner.”
The concepts of reflexivity differ from the equilibrium theory that permeates popular economic theories.
While equilibrium theory suggests long-run prices trend towards underlying fundamentals, reflexivity posits that self-reinforcing markets tend towards disequilibrium, which creates potential opportunities to profit. These tendencies ultimately cause the boom-bust cycles that shouldn’t necessarily occur under traditional economics.
Predicting Bubbles
George Soros made the majority of his money by predicting bubbles in international markets around the world using his reflexivity principles as a guiding light. Rather than trending towards an equilibrium, he believes that the financial markets perform in line with the biased expectations of the participants. Spotting the divergence of these biases from reality can highlight potential investment opportunities as a contrarian or trend follower.
For instance, the rise of conglomerates in the 1970s came about because price-earnings multiples were increasing faster than other areas of the economy. Conglomerates eventually overextended themselves and suffered major losses, but nobody really stepped back and took time to analyze why conglomerates were being formed at the beginning – they just jumped on the trend and the price earnings multiples simply kept rising.
Soros also believes that regulators tend to be behind the private sector in terms of regulating these bubbles, which means that these opportunities continue to exist and will probably continue to persist over the coming years.
More Information
International investors looking to learn more about these concepts can read George Soros’ book on the subject, called The Alchemy of Finance, or his many essays that have been published across several different financial publications.
In addition, those interested in following Mr. Soros’ trades can do so by looking at his 13F-HR SEC filings where he’s required to disclose certain positions in his portfolio.
Key Takeaway Points
- George Soros is a billionaire investor that’s famous for spotting bubbles and capitalizing on them with very decisive macroeconomic bets.
- Mr. Soros attributes much of his success to the concept of reflexivity, which he has diligently applied to the financial markets.
- International investors looking to capitalize on these dynamics may want to take a closer look at these concepts and apply it to their own trading.