Main Lesson: An insight into the psychology of Financial Economics
This was a very hard read. And after finishing the book, I feel like I have a grasp of the abstractness of what he tried to portray. While also obtaining a glance of the underlying concept he tried to convey. The Alchemy of Finance in my honest opinion can’t really be considered a book on how to get rich, nor can it really be considered a book on investing. This to me was a look inside the mind of one of the richest men in the world. Throughout the book I could just feel him read his own words and come through realizations as he went through them. This to me felt more like the diary of a genius investor who tried to come to terms with the absurdity of the market while trying to show that it can be somewhat rationalized.
In my limited understanding of the complete image of what he tried to teach me in this book I will try to tell you what I learned. The market is by definition flawed. Because the market functions on a set of principles that without those it would crumble upon itself. One of the big principles this book mentions is the concept of the Efficient Market Theory and that the market is always right. Soros, to combat this theory developed the concept of Reflexivity. Which means: “The participants’ perceptions are inherently flawed, and there is a two-way connection between flawed perceptions and the actual course of events, which results in a lack of correspondence between the two.” The book is filled with lines like these and they threw me for a loop more than a few times. Soros mentions several times in the book that he loves dealing with abstract concepts. But in laymen terms it means that the people who are in the market can’t really see the market for what it is, but rather see it how they want to see it. And because they see it how they want to see it, the market tends to actually reflect that. Right there is the connection between the two that a lot of economists tend to ignore, according to the book.
This perception of the people in the market is then of course their own Bias. This bias can be both negative or positive which will then affect the market in the exact same way, pushing the value up or down. So Soros states that by understanding and reading the mind state of the people in the market it is possible to see what is going to happen. Because most stock markets tend to move in trends. The trend is then of course for the market to Boom and then Bust.
What was very interesting is that Soros actually went head to head with “A Random Walk Down Wallstreet” stating that with his methodology he was indeed able to beat the market for several years. Which means that he was able to make money by indeed timing the market. But he does go on to state that he was extremely in tune with the market. To the detriment of his interpersonal relations as he got so swallowed up in the market that it became the top priority in his life. And as he stepped back to become a bit more social he lost his affinity with the market. Which to me translates to that it is possible to time the market and beat the market, but it has to be literally all you do, all day every day. And I doubt that many of us want to live that way. Another very interesting point he made is the concept of treating the market as a place to test hypotheses. This really got my attention, because by doing this he doesn’t only effectively remove his emotions from the situation but it can allow him to objectively look at his successes and failures and see where and how he went wrong. He mentions in the book that this exact same method of trial and error is being done in the market, the only difference is that the people in the market aren’t aware of it, so they aren’t able to learn from it. He does admit that this method isn’t perfect and at times he doesn’t learn anything from it, but if he does see a pattern or he can form a theory around a possible investment, it can pay off very handsomely.
The Alchemy of Finance seems to be a direct challenge to the finance theories that are floating around. Soros actually states: “As an undergraduate I studied economics, but I found economic theory highly unsatisfactory because it failed to come to grips with the problem; indeed, it went through great contortions to avoid it. Economics seeks to be a science. Science is supposed to be objective and it is difficult to be scientific when the subject matter, the participant in the economic process, lacks objectivity.” Which to me is a beautiful sentiment because the pursuit if science is the truth. The truth of how the world works, what the laws of governance are and how humans can use them to their advantage. But these truths are all based on facts. In finance theory the people in the market play a huge factor in its existence and their own personal perspective will play a part in the overall success of failure of the market. And no matter how many people try to convince you otherwise, an opinion or point of view is not a fact. And thus it is somewhat impossible to objectively gauge the market because it lacks coherent facts to be used as a valid science. And in this particular case he is talking about all social sciences.
And with that in mind, the concept of the market adhering to the laws of nature in that it will eventually correct itself is thus flawed. Because the parts that make the market run are capable of thought and can thus change it. Whereas the parts in nature move without thought.
Yeah, the book went deep. It goes into even more detail about how the concept of the market reaching an equilibrium is near impossible. Because the people within the market will at all times have a biased view of the market and thus it can never resolve itself. Because the value of the market is always wrongly gauged. Another concept he attacks is the theory of Perfect Competition. Because it is based on the premise of perfect knowledge, which isn’t possible as long as the participant is part of the market itself.
This book was very interesting. More so for the insight I gained from looking into his mind and thought patterns as he just wrote what he thought. What I really loved in this book is the fact that he fully embraced the contradictions in life and how they helped him come to terms with the abstractness of it all. The epilogue was without a doubt my favorite chapter of this book. Because its there that he is completely honest and even gives his personal view on life and death and the pursuit of perfection. This book is not an absolute must read on your path of financial freedom or becoming rich. But if you do insist on day trading and trying to time the market. Reading this book until you fully grasp what one of the best investors ever has to say, might just be the right way to go for you. This was a very pleasant palette cleanser after my last book.