What Traders Can Learn Following George Soros Trading Approach & Strategies

by Tom Black
What Traders Can Learn Following George Soros Trading Approach & Strategies

In the world of investing, the name George Soros is known by almost everyone. This Hungarian-American billionaire investor and philanthropist garnered quite the media attention when he “broke” the Bank of England. He is the owner of two hedge funds – Soros Fund Management and Quantum Fund, which was previously named Double Eagle. 

How did George Soros come to the limelight?

Soros’s trading activities are manyfold, as he does not limit himself to a particular geographical area. In September 1992, after borrowing $10 billion dollars’ worth of British pounds, he converted them into German marks. His opportunity came when the pound crashed, after which he repaid the lenders according to the new, declined value of the pound. As a result of this, he made a direct profit of $1 billion, which went up to $2 billion after he unwound his position. 

His trading strategies and approach 

Traders have always been advised about sticking to their trading methods, which is crucial in achieving success. In the simplest terms, discipline requires overriding one’s gut feelings. However, few traders know how to separate emotion from actual knowledge. Soros uses the theory of reflexivity to analyze markets. According to him, prices are mainly influenced by a continual feedback loop between the thinking of the participants on one side and the economic realities of the market on the other. This circular process was dubbed “reflexivity “ by George Soros. We have summarized George Soros’s advice on various trading issues over the years into the points below. 

Fallibility

Most traders normally have the belief that the market is always right. However, Soros takes the opposite position, as he assumes that markets are wrong. This assumption, although surprising, forms the basis of his operating principle. He believes in fallibility as, according to him, it is impossible to form a mental picture of the world without taking in distortion. 

When we normally open a trading position, we are actually testing a trading hypothesis, ranging from simple “price is going up/down” to more complex trading systems based on macro global economic forces. On the other hand, the market itself can be said to constantly adapt to changing hypotheses. In other words, when one hypothesis fails, the markets move on to another. 

Soros normally looks for profit opportunities in situations where the prevailing bias is having an unintended effect on the market, which cannot be seen from the conventional hypothesis.  Markets are always biased. The market’s hypothesis can seem to be confirmed at first at the explicit level, which can reinforce a trend. However, at an underlying, implicit level, the action of the market can create a very different effect that eventually makes the trend unsustainable. 

Finding Flaws in your own trading hypothesis

According to Soros, the fact that a trading hypothesis is flawed doesn’t mean that he won’t commit money. He instead looks at whether other people believe in the hypothesis. He advises us to commit money until the point there is a large group of people who are likely convinced of the validity of the trading hypothesis. 

So how does Soros find them? He simply combines theory and instinct, which are generally considered mutually exclusive. Generally, when traders use their instincts, they tend to override their own methodology. But Soros is of the opinion that instincts and theory are inextricably linked. 

Reflexivity

Soros uses the theory of “reflexivity” to understand how the market operates. This theory holds that the markets are always biased. Hence, prices can never be unbiased as they assist in shaping the fundamentals that they are supposed to reflect. As reflexivity introduces uncertainty into the system, Soros believes that the same methods used in natural sciences cannot be used to predict market behaviors. Soros’ theory of reflexivity aims at explaining how trends are formed and what makes them reverse. This does not provide any rules or indicators for catching the trend or reversal but gives us an idea of where to look. 

Trend formation and reversal

Soros’ method of trading involves technical analysis on the one hand with fundamental analysis on the other. However, the combination of Soros uses does not get affected by the limitations of each method. Soros first starts by finding out the participant’s bias, which results in trends that need to be followed.  Soros then looks for the flaw in the rationale behind the trend. It should be remembered that strong trends only form when there is substantial consensus among the different groups of market participants. Finding the flaw, in this case, puts him ahead of other traders. 

Soros still follows the trend but also looks out for any potential reversals. In a situation that is reflexive, the market trend can, at first, support the bias as they reinforce each other. However, the trend also has unintended financial consequences, which the conventional trading view does not take into account. Thus according to Soros, any market hypothesis is merely based on a piece of a multi-layered web of information that is constantly evolving. 

Soros’ profit opportunities

Some of the greatest profit opportunities found by Soros involve finding situations in which a market trend supports a prevailing bias at first. A classic example would be the conglomerate boom of the 1960s, where prevailing bias over emphasized earnings growth over other fundamentals. When their stock prices rose, these companies increased their earnings by using their increased stock value to procure other companies.  This resulted in a further increase in stock prices. The trend gained momentum until the point where corporate results could no longer sustain the expectations of investors. 

Here the main flaw was that sustainable growth was only possible when company acquisitions continue to increase at an alarming rate. In this case, the turning point was reached when the famed Leasco Corporation failed to acquire Chemical Bank, which brought the flaw to public attention. The flaw can take many forms, as each situation is different. What the flaw turns out to rest entirely on the nature of the prevailing bias in the market, as well as the market itself. There are no hard and fast rules for finding out the flaw, but Soros gives us a direction in which to look. 

Final Thoughts

The method in which Soros’ body and theory work together during trading remains a mystery for many. However, trading like him is not for the faint-hearted. Traders should thus remember that if they cannot afford to take big losses, they cannot afford to bet as big as Soros. He has made the right investing decisions over the course of three decades, which makes his investment advice of utmost value. 

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