Lesson from Soros Stands the Test of Time

For markets in general, this perspective provides a ready explanation for boom/bust sequences and financial crises. Mr. Soros rails against equilibrium-centered traditional economics for its inability to deal with such realities, and encourages alternative lines of inquiry. In recent years behavioral finance, a new type of economics based on a realistic depiction of human behavior, has developed explanations consistent with the Soros approach.

Trial and Error

General models do not always translate into money-making practice. For instance, Mr. Soros lost money in the 1990s technology bubble despite being familiar with boom/bust cycles. But his philosophical musings provide one insight of great practical significance: Traders need to be adaptive because there is no way of knowing beforehand how a market situation will turn out.

The Quantum Fund experience demonstrates how that works. Mr. Soros recorded the investment decisions he made from August 1985 through November 1986, at the time he made them. This remains a fascinating exercise in global macro strategy; a master speculator’s take on commodity, currency and equity markets.

His account is a litany of doubts, hazards and mistakes. He is skeptical of a widespread thesis that the economy is strengthening but is not sure. He is short the dollar but is afraid of the risk. He is carrying a short position in oil, and it is getting expensive. At one point he writes, “My crystal ball is cloudy.”

He’s been losing on currency trades for several years. Then in September 1985, he makes a killing by buying a lot of yen just before central banks switch to a new exchange rate system and the yen rises. There is a pattern: He sustains losses, reduces positions, gets out, then sees a great opportunity and pounces. In short, he constantly and quickly adapts to events.

In January 1986, stock and bond markets collapse, mauling his portfolio. He pulls back, but by March feels he moved too soon to reduce leverage, thereby missing the best of a bond rally. Despite various setbacks and doubts that were sometimes paralyzing, Quantum Fund’s NAV per share rose 121% in 1985 and 43% in 1986. Such numbers make for legend and Mr. Soros became one.

How did he do it? He keeps an open mind and continually modifies his outlook with new information. As he says, “the markets provide a merciless reality check,” and Mr. Soros never stays with an idea that fails the test. Most of the time he can’t predict what’s coming, but he promptly corrects course in response to feedback. That limits losses. On rare occasions he can see through the fog of uncertainty and hauls in the booty.

He learns what the market has to say and then beats it by understanding the message. “The main difference between me and the markets is that markets seem to engage in a process of trial and error without the participants fully understanding what is going on, while I do it consciously,” he says.

This is not an easy book to read, but as another hedge fund manager describes it in the foreword, it is a timeless guide. “When I enter the inevitable losing streak that befalls every investor, I pick up ‘The Alchemy’ and revisit Mr. Soros’s campaigns,” writes Paul Tudor Jones.

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