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As my Christmas gift to you, I am providing you with one of my favorite Global Guru columns of the past that offers timeless investment advice that I hope you find of value. Merry Christmas!

George Soros — alongside Warren Buffett — is considered to be one of the greatest investors of all time. In 1994, George Soros wrote a book about his investment philosophy called the The Alchemy of Finance in which he proposes his “Theory of Reflexivity.” Soros gave his theory such a grand-sounding name so that it would sound like Einstein’s “General Theory Of Relativity.” Soros thought it would be that important.

Because of Soros’s status in the investment world, The Alchemy of Finance turned out to be one of those books that every Wall Street professional said they had read — but I doubt any of them got through it, let alone understood it. That did not keep high-profile, Wall Street strategists like Barton Biggs from calling it “a seminal investment book… it should be read, thought about, underlined page by page, concept-by-idea… (Soros) is the best pure investor ever… probably the finest analyst of our world in our time.”

GEORGE SOROS’S #1 INVESTMENT SECRET: TACKLING “THE ALCHEMY OF FINANCE”

When I was managing my first investment fund over 15 years ago, I decided that I really wanted to get inside Soros’s head. So I picked up The Alchemy of Finance and took Barton Biggs’s advice.

I read it once… I didn’t get it…

I read it again…I still didn’t get it…

Now, keep in mind that I had been through Harvard Law School…

…So I was used to stirring concrete with my eyelashes…

…And getting through more turgid and bombastic doublespeak than you could shake a stick at…

But Soros made federal court cases seem like nursery rhymes.

Then one day I ran across a quote from Soros’s own son. It made everything crystal clear, but not in the way that I expected.

“My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking, Jesus Christ, at least half of this is bulls**t, I mean, you know the reason he changes his position in the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm, and it’s his early warning sign.”

—George Soros’s son, Robert, on his father’s Theory of Reflexivity.

Soros himself essentially went on to criticize his own theory in the next edition of the book — admitting that it was essentially incomprehensible. Those who had claimed to have understood it in the first place were just fooling themselves.

GEORGE SOROS’S #1 INVESTMENT SECRET: CORRECTING FALSE PREDICTIONS

So if no one has a theory to explain the market — not even George Soros — what chance do you have to make money consistently in the markets? It turns out there is a secret to George Soros’s success. But it’s not one that you will find in books that discuss Soros’s investment philosophy — and certainly not in The Alchemy of Finance. But once you understand and apply this secret, it will make your trading life much easier — and certainly less stressful.

The “secret” to Soros’s success is not the ability of the “Theory of Reflexivity” to explain or predict the market. In fact, the secret to Soros’s success is quite the opposite. I found it buried in an interview with Soros in John Train’s The New Money Masters, in what was almost a throwaway comment:

“My approach works not by making valid predictions but by allowing me to correct false ones.”

—George Soros

Now I could get into how this all has to do with Soros’s admiration for the philosopher Karl Popper and the limits of human understanding, but there is no room for that here. Comments from traders who have worked with Soros are more relevant.

From James Marquez, a former Soros Chief Investment Officer (CIO):

“Soros would be the first one to tell you that sometimes his actions… look like the most rookie, odd-lot, wrong-way kind of thing, selling at the lows, and buying at the highs. But it’s much easier to understand in light of his avowed mission: to be able to come and fight another day. He says: “I don’t want to wake up broke.”

And then, Alan Raphael, yet another Soros CIO:

“When George is wrong, he gets the hell out. He doesn’t say, ‘I’m right, they’re wrong.’ He says, ‘I’m wrong,’ and he gets out, because if you have a bad position on, it eats you away. All you do is think about it — at night, at your home. It consumes you. Your eye is off the ball completely. This is a tough business. If it were easy, meter maids would be doing it.”

Contrast that with how most of us think of trading or investing:

  • We develop an opinion on a stock.
  • We take a position.
  • We convince ourselves that we made the right decision. This is when a bad investment turns into a “long-term investment.”
  • And the “smarter” we are, the worse it is. We “know” we’re right. We “know” our investments will eventually “come back.”

Now, let’s examine how Soros would look at the same situation. Here’s my take on what Soros believes.

“The secret to my success is that I know that I will be wrong. I consider it a strength to admit my mistakes. That allows me to stay in the game and fight another day.”

GEORGE SOROS’S #1 INVESTMENT SECRET: HOW TO APPLY IT IN YOUR OWN TRADING

So how can you apply this approach in your own trading and investing? Understand that making money in the markets has much more to do with having proper exits and position-sizing (bet size) than it does the “Theory of Reflexivity” or any other hypothesis that claims to explain the market.

So the next time you come across a “can’t fail” investment idea, here’s what you should do:

  • Listen carefully and see if it “makes sense” to you.
  • If it reflects your own beliefs, then consider taking a position in it.
  • But no matter how terrific sounding the pick, make sure that you have your exits and position-sizing strategies in place.

If the position goes against you — which some inevitably will — reframe in your mind the idea that taking a loss is a strength. Make sure you cut your losses. And like George Soros, this will keep you from “waking up broke.”

Sincerely,

Nicholas A. Vardy
Editor, The Global Guru