Finance
by George Soros
Do prices just reflect reality?
Textbooks treat markets like scales that weigh the facts and settle on the right price. George Soros, who ran the Quantum Fund, thought that picture was wrong. Here he sets out the theory behind his trading, then tests it live on his own fund.
Hear a sample · read by Laura
Soros's central idea. People in a market act on what they believe, and their actions change the very facts they're trying to judge. The changed facts then shift their beliefs again. Thinking and reality keep pushing on each other, so there's no fixed value for prices to settle on.
Nobody fully understands a situation they're part of, so Soros says market prices always carry a prevailing bias. Sometimes the bias gets corrected. Sometimes it feeds on its own success, and the trend and the belief push each other further than the facts alone would.
Credit is one of Soros's main examples. Banks lend against assets such as property. The lending pushes up what those assets are worth, which makes borrowers look safer, which invites more lending. Run backwards, the same loop turns a slowdown into a rout.
Soros sketches a sequence. A trend starts unnoticed. Belief in it grows and speeds it up. It survives a test. Later comes a twilight period, when people keep going but no longer believe, then a crossover point and a crash. He traces it through the conglomerate boom of the 1960s.
Fallibility
Our understanding of markets is always incomplete, because we're part of what we're trying to understand.
Reflexivity
Investors' beliefs move prices, and those prices can then change the business itself. Soros calls this reflexivity.
Conglomerates
In the 1960s, high share prices let conglomerates buy other firms, which pushed their profits and prices higher still.
Boom and bust
A trend and a mistaken belief can feed each other for years before the gap grows too wide and it all reverses.
Collateral
Lenders judge loans by the collateral, but the lending itself pushes up what that collateral is worth.
A story from the book
From August 1985 Soros kept a diary of his thinking while running his fund. It caught the Plaza Accord that September, when the big economies agreed to push the dollar down. Soros already held large bets against the dollar and made a fortune. The diary records his mistakes too.
One thing to try
This week, find one story where belief is changing the facts. A soaring share price that lets a company buy rivals with its own shares, say, or a rumour that sends savers queuing at a bank. Then ask what would make the loop turn round.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. The Alchemy of Finance comes with a Name That Idea round to make it stick.
Get the whole book on KnotdOpen in the appDo prices just reflect reality? Textbooks treat markets like scales that weigh the facts and settle on the right price. George Soros, who ran the Quantum Fund, thought that picture was wrong. Here he sets out the theory behind his trading, then tests it live on his own fund.
Reflexivity; Every market leans; Lending lifts the collateral; How a boom unfolds.
This week, find one story where belief is changing the facts. A soaring share price that lets a company buy rivals with its own shares, say, or a rumour that sends savers queuing at a bank. Then ask what would make the loop turn round.
Yes. Knotd has the key ideas from The Alchemy of Finance in a few minutes, in plain words, plus a Name That Idea round to test them. It's one of 250+ non-fiction books in the app.
