The market does not simply follow objective laws; rather, it is influenced by the subjective consciousness and expectations of investors.

When we talk about value investing, there is a situation where investors, upon discovering that a project they are optimistic about has seen its token price rise, feel they have made money. Seeing those around them profiting makes them more willing to invest more funds. This optimistic sentiment not only benefits investors but also profits the project parties. The rising token price also brings profits to the project parties, and at this time, analysts will promptly release various positive reports, emphasizing the project's fundamental advantages and that it is an unprecedented innovation, further encouraging investors to buy in. This atmosphere will drive up the token price, and the price increase, in turn, validates the confidence of both investors and project parties, forming a self-reinforcing feedback loop.

This is a vivid interpretation of George Soros's "theory of reflexivity" in the capital market. The market does not simply follow objective laws; it is influenced by the subjective consciousness and expectations of investors. The fluctuations in market prices not only affect investors' views but also these views can react back on the market, creating a cycle. This is a typical process of "cognition and reality influencing each other," which is what we mean by "understanding changes reality, and reality changes understanding."

What is Reflexivity?

"Reflexivity" originates from the English term "reflexivity," widely used in modern humanities and social sciences, referring to a more structured process of self-reflection, distinct from general reflection. This concept emphasizes self-reference and deep self-reflection.

Soros's "principle of reflexivity" explains the close connection between our thinking and reality. In this theory, an individual's way of thinking can directly influence the state of reality. For example, when you believe the market is entering a bull market, this judgment is not just an opinion but more of an attitude. This attitude is unconsciously transmitted among investors and the market. The market receives the heightened emotions and buying behaviors from investors, thus forming a bull market. Influenced by the optimism of the bull market, investors reflexively project more buying behaviors into the market, which further strengthens more investors' judgments of the bull market signals, deepening people's conviction that the market is in a "bull market."

This positive signal will immediately activate market reactions, and the market will reflect back with more emotional incentives. This incentive and a series of market-related reactions will further confirm investors' judgments, making them more convinced that this is a good signal: I need to increase my investment to gain greater benefits.

Over time, investors' behaviors and attitudes amplify in the market, and the interaction between both sides shapes a "mapping game." Ultimately, they increasingly believe that their initial judgments are correct, and this self-confirming cycle allows the market to continuously develop in line with investors' optimistic expectations. Thus, both observers and market participants become involved in a self-fulfilling cycle, and the market ultimately performs as expected.

"Self-Fulfilling Prophecy"

Soros believes that investors in financial markets cannot obtain complete information, leading them to form "investment biases." These biases are the fundamental driving force of financial markets; they continuously reinforce in the market and create a collective influence, triggering a butterfly effect that pushes the market in a single direction, ultimately leading to a market reversal. This is known in capital markets as a "self-fulfilling prophecy."

Soros's investment philosophy is based on a fundamental assumption that "the market is always wrong." However, he has a systematic theory to explain why the market makes mistakes. This theory is crucial for him to profit from the market's errors.

So, how do we understand this theory of reflexivity? The change in market prices triggers changes in market prices; this is a self-reinforcing cyclical process. By utilizing this theory, we can uncover markets that are overreacting, track the process of the market forming trends, self-propelling, and ultimately leading to decline, and capture its turning points, which is precisely where the greatest investment opportunities lie.

Here is an example of a common phenomenon in our investments:

When we see the Ethereum Foundation selling tokens, it often seems they sell at the peak. Investors will perceive this as a sell signal, leading to a rush of followers who panic sell, creating an irreversible trend behavior, thus forming a strong consensus that "Ethereum cannot hold." There are many similar phenomena; a simple wallet reorganization by the project party can also be interpreted as a sell-off, triggering a series of butterfly effects that crash the token price, which is not uncommon.

The reason behind this phenomenon is the mainstream bias formed by following the trend, which is the main reason for the market's overreaction. Although the actions of followers have a certain degree of blindness, they can strengthen the market's own trend. Due to the complexity of market factors, the more uncertainties there are, the more followers there will be, and the impact of this speculative behavior of following the trend will be greater. In fact, this influence itself has become one of the fundamental factors that dominate market trends.

This is also why price outcomes often deviate from macro predictions:

In the crypto market, investors' emotions and market perceptions can directly impact prices. If investors generally believe that a certain cryptocurrency will appreciate, they may buy in large quantities, thus driving the price up. This price increase will further reinforce this belief, attracting more investors into the market. This is a feedback loop of perception and behavior.

Moreover, due to the rapid and complex dissemination of information in the market, market participants often make decisions based on incomplete or distorted information. This information asymmetry can lead to an unbalanced state in the market, causing short-term violent price fluctuations. This is also what Soros refers to as the lack and asymmetry of market information.

Additionally, reflexivity is also manifested in the crypto market through collective behavior. For example, when a large number of investors react similarly to a certain news or event, the market often experiences violent fluctuations, a phenomenon particularly common among so-called "whale" investors. Ultimately, the market bubble caused by reflexivity will be corrected and adjusted. Overly optimistic market sentiment may drive crypto assets far beyond their true value. When the market realizes this, a sharp correction will occur, and prices will fall back to more sustainable levels.

This reminds me of a discussion we had in August during a Space about the expectations of interest rate cuts and the possibility of recession, as well as the impacts of cutting by 25 or 50 basis points. (Links: https://x.com/XTExchangecn/status/1823552350260486244)

We talked about how when the first interest rate cut begins in September, the Federal Reserve would shift from a tightening policy to a relatively loose stance to prevent potential weakness in the job market. This marks a shift in the market's focus from inflation to the labor market, which is a key indicator for determining whether the market is in recession.

At that time, the prediction was: if the rate cut was 25 basis points, it would support the argument for a defensive rate cut, proving that the U.S. economy is still healthy. But if it was 50 basis points, the market might experience a brief and significant rebound, but it would also mean that the Federal Reserve is trying to save the market, and the risk of recession is approaching.

However, the actual market reaction after the rate cut was different from expectations. A 50 basis point cut led to a solid rebound in the market, rather than a panic of recession, and the bottom price of BTC is continuously being raised. The general view among rational investors is that global monetary easing policies will only bring short-term economic prosperity, which will lead to instability in the stock market and even exacerbate the risk of recession. Therefore, investors need to remain vigilant and optimistic. Although many rational investors hold a pessimistic attitude, they cannot resist the influence of the majority of optimistic investors. These optimists believe that the benefits brought by global monetary easing and the soaring stock market will correct the excessive panic caused by recession and the Sam Law, leading investors to cautiously and optimistically view the future market. The market's trend is indeed influenced by investor behavior, and analysts' predictions will also be corrected by the real-time market trends. This is a mutually interactive reflexive relationship, and the interaction between investors and the market will ultimately determine the market's trend.

Investors' behaviors largely depend on their experiences. If they have made money in the market, they tend to hold an optimistic attitude towards almost everything. For example, if a person receives positive feedback at work, gets promoted, and receives a raise, they will feel more confident and optimistic, making it easier to succeed in other endeavors when in a good state. Conversely, if a person has encountered many setbacks recently, their self-efficacy will be diminished, leading to more poor decisions or even falling into self-doubt.

The financial market is no different; after receiving substantial returns, people are often more willing to increase their investments and believe they are in a good market due to the positive feedback. Soros once said, "Each of our worldviews is flawed and distorted, so our understanding of reality is incomplete." The market is often swayed by investors' exaggerated biases. This also explains why investors are so easily influenced by market sentiment and find it difficult to make rational judgments.

The market constantly oscillates between two extremes: on one hand, "distorted revelry," and on the other, "correcting errors." Short-term market deviations will always be corrected; what investors need to do is seize the opportunity to exit before most people are still immersed in optimistic sentiment. Otherwise, by the time they realize their mistakes, it will be too late.

Soros developed an investment strategy based on this understanding that "human understanding of reality is incomplete." He believes, "Our incomplete understanding is a factor that influences events, and the events influenced by distorted understanding, in turn, affect our understanding." This process is a reflexive process, and investors need to remain vigilant about this reflexivity to avoid being swayed by market emotions.

We can further break down the interpretation of reflexivity theory:

1. The first step is background assumptions:

The development trend of the market is not yet clear, and investors are waiting for clear signals. For example, after the significant drop in August, before the extent of the U.S. interest rate cut is determined in September, the market's development trend has not yet been concluded; this is a process of background assumptions.

2. Next, depict the crystal ball:

After the interest rate cut is confirmed, investors' attitudes sway back and forth, leading to polarization. Some believe that the rate cut will lead to significant monetary easing, benefiting the risk market as a whole, while others believe it triggers the Sam Law, and a 50 basis point cut means a greater risk of impending recession. Investors seem to be depicting their crystal ball, projecting their thoughts onto it, and the ball will reflect investors' behaviors and thoughts accurately.

3. The crystal ball reflects the depicted results, mapping the market:

Ultimately, a trend is established, and the market achieves a successful upward test. Initially, this test does not receive universal recognition. As the market trend develops and more people profit, this upward result is tested repeatedly through various shocks. This recognition will strengthen the upward trend's development and lead to the beginning of a self-propelling process.

4. Acceleration process:

As the trend and skewed perceptions mutually promote each other, biases become increasingly exaggerated. When this process reaches a certain stage, the level of conviction further increases. The interaction between the two causes investors to fall into blind frenzied emotions; the stronger the trend, the further the bias deviates from the truth, and at this point, the market is actually hiding a vulnerability that can be corrected at any time.

5. The market forms biases and cognitive deviations:

Investors overly trust and exaggerate the test results, leading to a belief that deviates too far from reality. The biases of market participants become evident, and when this revelry reaches a climax, the driving effect of people's views on the market begins to diminish, the original trend stagnates, and another voice begins to influence the market.

6. Correction:

When another voice emerges, the original market confidence begins to wane, and the market starts to shift in the opposite direction. This turning point is called the intersection. The result of the market's overreaction ultimately leads to the phenomenon of prosperity and decline interacting.

Summary

Soros's theory of reflexivity challenges the traditional efficient market hypothesis, emphasizing the market's incomplete efficiency and dynamism. Investors' expectations and behaviors can, in turn, influence market trends, forming a complex feedback mechanism. This theory provides a new perspective for understanding the complexity and volatility of financial markets and offers good opportunities for value investors.

Recently, the U.S. stock market has reached new historical highs, driving a comprehensive rebound in the crypto market. After the release of the CPI data in September, market confidence was significantly boosted, and the performance of major banks' financial reports also ignited traders' enthusiasm. JPMorgan even stated that the U.S. has currently reached a low inflation target, and the economy has achieved healthy growth, realizing the widely discussed soft landing. Currently, the market has entered a generally optimistic atmosphere, and encouraged by this positive sentiment, it will undoubtedly reflect more positive signals in the short term, once again positively impacting the market. The optimistic sentiment is like a snowball, and the momentum expected to push the market upward will become increasingly strong.

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