George Soros is a lot of things. Most of which I just don’t get.
He is the founder of the Open Society Foundations throughout the world. They played a big role in subverting the Soviet Union.
Since the fall of the Soviet communism, however, Soros has been going the exact opposite way. His political organizations have been increasingly active in supporting socialism and centralized control throughout the world.
I just don’t get how the two can be aligned and probably never will either.
But one thing I do understand completely about Soros is how he made his fortune.
If you’ve read any of his many books, he’ll openly reveal the simple formula he followed to build his $24 billion fortune.
Today though, you don’t have to read his lengthy(!) books. I’ll just distil it for you.
Soros’ Major Weak Spot
Soros is one of the greatest traders in the history of the world.
For a long period of time his Quantum Funds even outpaced the returns of Warren Buffett.
Soros, however, had a major weakness. A weakness that gives you us an advantage.
The one thing Soros wants to be above all else is a philosopher.
He wanted to develop theories, get the world to accept them, and put them all down in books for history.
That desire gives lets us see exactly how Soros built his estimated $24 billion fortune and some tips we can use to make ourselves more successful investors.
After reading a lot of Soros over the years, I can tell you the one overriding theory that drove his entire success is also really simple.
It’s a concept Soros called “reflexivity.”
Investopedia defines reflexivity as:
The idea that a person's thoughts and ideas tend to be inherently biased. In other words, the values and thoughts of a person will be represented in their work.
In the context of finance, the theory of reflexivity states that investors' and traders' biases can change the fundamentals that assist in determining market prices.
Now, I’ll admit, there’s a lot more to reflexivity than that. Hundreds and hundreds of pages more.
It’s all based on the ideas of Karl Popper and how we cannot see reality because we are inherently biased because of reality.
Or, maybe a better way to say it is we all see a different reality, but there’s only one reality.
It’s deep philosophy stuff for which you may not be interested and, if you were interested, you know there are far better sources than I on the subject.
The main part we want to focus with reflexivity is it’s impact in the markets and, to put it bluntly, how we can use them to make money off it.
Real Time Reflexivity
We look at reflexivity as the formation and reinforcement of the market community’s biases in the market.
In other words -- and as we’ve said before -- market trends tend to follow both up and down far higher and lower than most investors ever expect.
It’s basically the old rule of buying begets more buying and selling begets more selling.
This is true in so many cases.
It’s why we wait for stocks to fall ideally down 80%, 90%, and sometimes more before we buy in The Cheap Investor.
Moving in too early is often the biggest risk because reflexivity can and often does drive stocks that have fallen a lot down even further.
The theory of reflexivity also works at the other end of the spectrum too. The exact opposite of cheap stocks. Stocks that are already well into a period of rising steadily.
These are the “momentum” stocks you’ll be learning more about very soon.
With these stocks reflexivity reinforces the uptrend. Buying begets more buying.
After all, if a stock’s going up, something must be right...right?
Reality doesn’t matter. It’s the perception. And it’s why stocks go up and up until panic buying sets in, there are no buyers left, the price collapses, and the cycle begins anew.
But here’s the really important part about this theory and momentum stocks.
Simply put, it works.
In James P. O’Shaughnessy What Works on Wall Street, he found that: If you’d bought the top 10% of performers over the preceding six months for each time period he looked at, you’d have made more than half a billion dollars.
In another study, O’Shaughnessy’s son Patrick found found that: Since 1963, a strategy that buys the top group (best 10% of the market) of stocks by 6-month total return, has delivered a 14.4% annual return, which is roughly 4.5% better than the S&P 500.
Those are huge numbers and are very important consideration right now that markets are hitting all-time highs once again.
The Only Two Ways to Win in Stocks Today
We continue to see only two ways to win in the current market.
As always, we have our bread and butter of buying cheap stocks. Not just cheap stocks, but ultra-cheap stocks. Those down 80% or more and of shares in a business that has a deep, but temporary and survivable, flaw or problem.
But I realize, this takes time. Sometimes a really long time to really pay off.
So if you are looking to outrun the markets more quickly, sticking to the stocks with the best momentum, many of them are headed for a buying frenzy.
Not all of them, surely. But enough that history has shown the returns in buying into them as a group can be enormously profitable and rewarding.
Remember, the simple idea behind reflexivity drives stocks and all assets to extreme highs and lows. If you stick to those two concepts, you’ll do very well. Just look at George Soros and his $24 billion fortune for proof.