Think and Invest Like George Soros

George Soros, one of the most successful investors and financial thinkers of our time, has developed a unique and unconventional approach to markets and investing. His philosophy is rooted in an understanding of market instability, the role of perception in financial trends, and the idea that markets are often wrong. Below, we explore Soros’ key principles and how investors can apply them to their own strategies.

1. Markets Are Unpredictable and Always Wrong

Soros dismisses the notion that markets can be precisely predicted. As he puts it: “The financial markets generally are unpredictable. So that one has to have different scenarios… The idea that you can actually predict what’s going to happen contradicts my way of looking at the market.”

He assumes that markets are always wrong, and this perspective allows him to identify mispricings and exploit them: “The prevailing wisdom is that markets are always right. I take the opposite position. I assume that markets are always wrong.”

2. Market Instability and Reflexivity

Soros developed the theory of reflexivity, which suggests that financial markets do not move toward equilibrium but are rather self-destabilizing. This means that investor perceptions influence market realities, leading to cycles of booms and busts. “I put forward a pretty general theory that financial markets are intrinsically unstable. That we really have a false picture when we think about markets tending towards equilibrium.”

This concept helps explain financial bubbles, where a solid fundamental trend is distorted by market misconceptions: “Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.”

Soros emphasizes that financial markets are inherently unstable and do not naturally move toward equilibrium: “The reality is that financial markets are self-destabilizing; occasionally they tend toward disequilibrium, not equilibrium.”

3. Betting on the Unexpected and Market Misconceptions

Soros believes in discounting the obvious and betting on the unexpected. He emphasizes that money is made by identifying trends that others overlook: “Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”

This principle aligns with his idea of spotting trends that are built on false premises: “Find the trend whose premise is false, and bet against it.”

He further elaborates on the role of economic history in financial trends: “Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend and step off before it is discredited.”

4. Understanding Bubbles and Crises

Soros has profited enormously from recognizing financial bubbles and knowing when they will burst. He explains that every bubble consists of a trend based on reality, combined with a market misconception: “Every bubble consists of a trend that can be observed in the real world and a misconception relating to that trend. The two elements interact with each other in a reflexive manner.”

His philosophy warns against blindly following market movements, as they often lead to disequilibrium: “Of course, speculation will always make a crisis worse. If there is a weak point, it will expose it.”

Additionally, he highlights how bubbles cannot be sustained forever: “If the bubbles contain a misconception, as they always do, then it can’t be maintained forever.”

5. Investing as a Scientific Hypothesis

Soros treats investing like a scientific experiment, testing hypotheses in the real world: “Making an investment decision is like formulating a scientific hypothesis and submitting it to a practical test.”

He views financial markets as a laboratory for testing hypotheses: “Taking this view, it is possible to see financial markets as a laboratory for testing hypotheses, albeit not strictly scientific ones. The truth is, successful investing is a kind of alchemy.”

His goal is not necessarily to be right but to correct false assumptions quickly: “My approach works not by making valid predictions but by allowing me to correct false ones.”

6. Risk Management and Position Sizing

One of the key tenets of Soros’ success is his ability to manage risk effectively. He understands that being right or wrong is not as important as how much money one makes when right and how much one loses when wrong: “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

He also emphasizes adjusting positions based on conviction levels: “Increase your bets when you are confident and scale down your positions when you don’t have conviction.”

7. The Role of Speculation and Market Morality

Soros does not shy away from the speculative nature of investing, recognizing that speculation will always be a part of financial markets: “There is very little difference between speculation and investment. The only difference is basically that investments are successful speculations because if you successfully anticipate the future you make a speculative profit.”

He also acknowledges that markets function without moral considerations: “No individual anonymous participant can influence the prices and therefore you really can speculate in the market without paying attention to morality. That’s one of the positive features of markets. That’s why they function.”

8. The Importance of Discipline and Patience

Despite his reputation for bold trades, Soros believes that successful investing is often dull and requires patience: “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”

Additionally, he recognizes the dangers of following the herd and stresses the need for independent thinking: “Start by assuming the market is always wrong, so if you copy everybody else on Wall Street, you’re doomed to do poorly.”

He also points out how momentum trends impact short-term volatility: “When a long-term trend loses its momentum, short-term volatility tends to rise. It is easy to see why that should be so: the trend-following crowd is disoriented.”

9. Market Prices and Complexity

Soros challenges the idea that markets are efficient and always reflect reality: “Market prices are always wrong in the sense that they present a biased view of the future.”

He argues that market distortions can affect the fundamentals they are supposed to reflect: “I contend that financial markets never reflect the underlying reality accurately; they always distort it in some way or another and the distortions find expression in market prices. Those distortions can, occasionally, find ways to affect the fundamentals that market prices are supposed to reflect.”

Additionally, he acknowledges the risks associated with complex financial systems: “Unfortunately, the more complex the system, the greater the room for error.”

Conclusion: Thinking and Investing Like Soros

Soros’ investing philosophy challenges conventional economic theories and emphasizes that markets are inherently flawed, reflexive, and prone to mispricing. His approach revolves around:

·       Recognizing and exploiting market misconceptions

·       Managing risk efficiently

·       Betting on trends that others misinterpret

·       Adjusting positions based on conviction

·       Understanding that markets are never truly in equilibrium

By adopting his mindset, investors can refine their strategies, make more informed decisions, and capitalize on the inherent instability of financial markets. Following Soros’ principles requires a mix of skepticism, boldness, and discipline—qualities that separate extraordinary investors from the rest.