Have you ever wondered what drives financial markets? According to George Soros in his book, The Alchemy of Finance, it all comes down to one concept: reflexivity. This key idea explores the impact of reflexivity on financial markets and how it plays a vital role in the investment decisions of successful investors.

So what is reflexivity? It is the idea that market participants' biases and actions can influence market prices, which in turn can affect the behavior of market participants. Soros argues that reflexivity creates a feedback loop between market prices and the participants who drive those prices. This feedback loop can cause prices to become disconnected from the underlying fundamentals of an asset, leading to market bubbles and crashes.

To illustrate this concept, Soros cites his experience in the currency markets. He explains that his own actions as a currency trader could influence the value of a currency, which in turn would affect the behavior of other traders. This feedback loop could cause the value of the currency to become disconnected from its underlying fundamentals. Soros argues that his success as a currency trader came from his ability to recognize and exploit this feedback loop.

Soros also applies the concept of reflexivity to financial markets more broadly. He argues that market participants' beliefs and biases can create self-fulfilling prophecies. For example, if investors believe that a stock is undervalued, they may buy the stock, driving up its price. This increase in price may then reinforce the investors' belief that the stock is undervalued, leading to further buying and price increases.

In conclusion, the concept of reflexivity is a powerful force in financial markets. Successful investors like Soros recognize and exploit this feedback loop to their advantage. By understanding the impact of reflexivity, investors can make better investment decisions and avoid the pitfalls of market bubbles and crashes.