Originally published at: https://blog.12min.com/the-alchemy-of-finance-summary/
Reading the Mind of the Market
Forget everything you learned about markets.
In our summary of “The Alchemy of Finance” by George Soros, we let you look into the mind of the billionaire, who looks at markets differently than most people do.
Maybe that is the road to success: adopting a new view or at least considering it.
Scroll down to find out what his theory is.
Who Should Read “The Alchemy of Finance”? Moreover, Why?You must have heard about George Soros and his remarkable career and philanthropy.
If you have, you probably already want to read the book. If you have not, read it anyway!
In “The Alchemy of Finance” he presents his theory which concludes that the markets and the financial system are rigged to protect the interests of the powerful.
Although we can find a great deal of criticism on this book, we recommend it because of its originality and because of the author writes it based on his experiences.
He is honest and talks about the way his opinions have changed over the years and about his forecasting errors. By doing that, he shows that he is preaching what he says: that mistakes are keys to success.
About George SorosGeorge Soros is the chair of Soros Fund Management. His charitable foundations give around half a billion dollars annually in as many as 50 countries for projects in different areas of society.
"The Alchemy of Finance Summary"George Soros once stated that the monetary idea of equilibrium is superfluous to ﬁnancial markets.
He did not stop there.
He even called it poisonous to traders.
Now, let’s explain this.
Traders make money when they take after trends. In other words, they profit when they accurately predict the expectations of other market participants. Hence, perceptions are the ones that drive the market and not fundamentals.
Trends happen because perceptions reinforce themselves until a point when some shock sends expectations on another path.
Soros clarified that a steady condition of equilibrium can’t exist because changing expectations continually reshape the market.
Soros is an advocate of the idea of reﬂexivity, which argues that what members think about a circumstance inﬂuences the circumstance, and the situation shapes the members’ reasoning.
In other words, their comprehension is continuously ﬂawed because they are trying to comprehend something that is inconsistent. This implies that individuals cannot know their circumstances since those circumstances are dependent upon what people think about them.
At first, it may be hard to grasp, but don’t worry, you will get it.
The most broadly acknowledged financial model in present-day ﬁnance is the theory of rational expectations. It recommends that present expectations give a full image of future events. Additionally, it suggests that market costs are efﬁcient, which implies that they consolidate and express the total impact of all accessible data.
Furthermore, this hypothesis proposes that ﬁnancial markets will push toward equilibrium based on members’ expectations. That is unless some external shock presents new data.
All things included, efﬁcient markets and rational expectations suggest that markets are capable of optimal allocation of resources.
However, the extensive evidence demonstrates this is false.
Why is the rational expectations hypothesis ﬂawed?
Because it proposes that market participants seek after their best interests. However, in reality, they do not settle on choices that are working to their greatest advantage. Instead, they act on what they believe is in their best interest.
They have a blemished understanding, so unintended results follow almost any choice they make.
In this manner, people regularly make choices that turn out not to be in their best interest, despite the fact that they believed they would be.
Key Lessons from “The Alchemy of Finance”1. The “Human Uncertainty Principle” 2. Power Relationships 3. What is To Be Done?
The “Human Uncertainty Principle”Humans are the most uncertain thing there is in this world. They build their social reality based on their view and understanding. They make decisions all the time based on no other reason than their beliefs or expectations. Certainty does not exist in its absolute form. So, people act on what they feel or think, and sometimes their actions result in something other than what they expected in the first place.
Power RelationshipsThere are two types of countries in this world’s financial system: those in the center and those on the periphery. Why is this important?
Well, we will give you one example for illustrative purposes.
International debts are denominated in the currencies of the center countries. This means that center countries to borrow money in their currencies, which gives them the power to use monetary policies to keep their economies stable. Peripheral nations, on the other hand, do not have this liberty because they borrow in foreign currencies.
What Is to Be Done?The theory of market equilibrium suggests that markets will optimally allocate resources. However, if equilibrium is not what markets are after, there is no remaining reason to suppose that the results will be optimal.
In fact, reflexivity and the already mentioned human uncertainty make sure that equilibrium is unachievable.
As a result, markets move toward instability. They have been unstable and will continue to be unstable. The world may need to find a way to bring stability and morality to the markets by assigning appropriate regulations and institutions.
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“The Alchemy of Finance” Quotes[bctt tweet="The markets provide a merciless reality check." username="get12min"]
[bctt tweet=“The concept of reﬂexivity is very simple. In situations that have thinking participants, there is a two-way interaction between the participants’ thinking and the situation in which they participate.” username=“get12min”]
[bctt tweet=“Only when the fundamentals are affected does reﬂexivity become signiﬁcant enough to inﬂuence the course of events.” username=“get12min”]
[bctt tweet=“Most of the misdeeds of the recent boom fall into two categories: a decline in professional standards and a dramatic rise in conﬂicts of interest.” username=“get12min”]
[bctt tweet=“The ﬁnancial markets are very unkind to the ego: Those who have illusions about themselves have to pay a heavy price in the literal sense.” username=“get12min”]