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George Soros and his General Theory of Reflexivity
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George Soros and his General Theory of Reflexivity

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George Soros and his General Theory of Reflexivity

There are a series of lectures George Soros has given via his Open Society Foundation, these took place at the Central European University (that he founded).


The one I want to open up for discussion here is the first of 5 in the series, it's named "General Theory of Reflexivity" and if you decide to watch it on youtube

it's here;



or it can be found on the following link, the next link also includes a Q & A session following the talk;

George Soros: Open Society, the Financial Crisis, and the Way Ahead | Open Society Foundations


In order that you can make a positive contribution to this discussion


either,

you need to be familiar with relexivity

or,

you need to be willing to learn more about it




Clearly I have an interest and have particular views on it, I will explain more about this in the next few days after the discussion develops some depth.

For the moment I would encourage you to watch the talk , since I believe you will get the idea better if you watch the whole talk however you could start the youtube video at 22 mins 14 seconds (it's 52 minutes long), if short on time, this is the part where he introduces his theory of reflexivity and explains what reflexivity is.

Those looking to participate more in this website's forum discussions or other topics are especially welcome to join in here now particularly those who have no previous knowledge of reflexivity, this is a great opportunityto hear from you.


Regards and I hope youlook forward to the discussion.



PositiveDeviant

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$22 billion +

One of the most successful traders of all time and no one is even interested....?

How very curious.


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Here is a written version, where he explains it. This is an excerpt from an ft.com article that appears to be a transcript of the whole of the first lecture, I have only excerpted the salient section, which is the middle part of the lecture.


"So here it goes. Today I shall explain the concepts of fallibility and reflexivity in general terms. Tomorrow I shall apply them to the financial markets and after that, to politics. That will also bring in the concept of open society. In the fourth lecture I shall explore the difference between market values and moral values, and in the fifth I shall offer some predictions and prescriptions for the present moment in history.


I can state the core idea in two relatively simple propositions.
One is that in situations that have thinking participants, the participants' view of the world is always partial and distorted. That is the principle of fallibility. The other is that these distorted views can influence the situation to which they relate because false views lead to inappropriate actions. That is the principle of reflexivity. For instance, treating drug addicts as criminals creates criminal behavior. It misconstrues the problem and interferes with the proper treatment of addicts. As another example, declaring that government is bad tends to make for bad government.


Both fallibility and reflexivity are sheer common sense. So when my critics say that I am merely stating the obvious, they are right—but only up to a point. What makes my propositions interesting is that their significance has not been generally appreciated. The concept of reflexivity, in particular, has been studiously avoided and even denied by economic theory. So my conceptual framework deserves to be taken seriously—not because it constitutes a new discovery but because something as commonsensical as reflexivity has been so studiously ignored.


Recognizing reflexivity has been sacrificed to the vain pursuit of certainty in human affairs, most notably in economics, and yet, uncertainty is the key feature of human affairs. Economic theory is built on the concept of equilibrium, and that concept is in direct contradiction with the concept of reflexivity. As I shall show in the next lecture, the two concepts yield two entirely different interpretations of financial markets.

The concept of fallibility is far less controversial. It is generally recognized that the complexity of the world in which we live exceeds our capacity to comprehend it. I have no great new insights to offer. The main source of difficulties is that participants are part of the situation they have to deal with. Confronted by a reality of extreme complexity we are obliged to resort to various methods of simplification—generalizations, dichotomies, metaphors, decision-rules, moral precepts, to mention just a few. These mental constructs take on an existence of their own, further complicating the situation.

The structure of the brain is another source of distortions. Recent advances in brain science have begun to provide some insight into how the brain functions, and they have substantiated Hume's contention that reason is the slave of passion. The idea of a disembodied intellect or reason is a figment of our imagination.

The brain is bombarded by millions of sensory impulses but consciousness can process only seven or eight subjects concurrently. The impulses need to be condensed, ordered and interpreted under immense time pressure, and mistakes and distortions can't be avoided. Brain science adds many new details to my original contention that our understanding of the world in which we live is inherently imperfect.



The concept of reflexivity needs a little more explication. It applies exclusively to situations that have thinking participants. The participants' thinking serves two functions. One is to understand the world in which we live; I call this the cognitive function. The other is to change the situation to our advantage. I call this the participating or manipulative function. The two functions connect thinking and reality in opposite directions. In the cognitive function, reality is supposed to determine the participants' views; the direction of causation is from the world to the mind. By contrast, in the manipulative function, the direction of causation is from the mind to the world, that is to say, the intentions of the participants have an effect on the world. When both functions operate at the same time they can interfere with each other.

How? By depriving each function of the independent variable that would be needed to determine the value of the dependent variable. Because, when the independent variable of one function is the dependent variable of the other, neither function has a genuinely independent variable. This means that the cognitive function can't produce enough knowledge to serve as the basis of the participants' decisions. Similarly, the manipulative function can have an effect on the outcome, but can't determine it. In other words, the outcome is liable to diverge from the participants' intentions. There is bound to be some slippage between intentions and actions and further slippage between actions and outcomes. As a result, there is an element of uncertainty both in our understanding of reality and in the actual course of events.

To understand the uncertainties associated with reflexivity, we need to probe a little further. If the cognitive function operated in isolation without any interference from the manipulative function it could produce knowledge. Knowledge is represented by true statements. A statement is true if it corresponds to the facts—that is what the correspondence theory of truth tells us. But if there is interference from the manipulative function, the facts no longer serve as an independent criterion by which the truth of a statement can be judged because the correspondence may have been brought about by the statement changing the facts.


Consider the statement, "it is raining." That statement is true or false depending on whether it is, in fact, raining. Now consider the statement, "This is a revolutionary moment." That statement is reflexive, and its truth value depends on the impact it makes.


Reflexive statements have some affinity with the paradox of the liar, which is a self-referential statement. But while self-reference has been extensively analyzed, reflexivity has received much less attention. This is strange, because reflexivity has an impact on the real world, while self-reference is purely a linguistic phenomenon.

In the real world, the participants' thinking finds expression not only in statements but also, of course, in various forms of action and behavior. That makes reflexivity a very broad phenomenon that typically takes the form of feedback loops. The participants' views influence the course of events, and the course of events influences the participants' views. The influence is continuous and circular; that is what turns it into a feedback loop.


Reflexive feedback loops have not been rigorously analyzed and when I originally encountered them and tried to analyze them, I ran into various complications. The feedback loop is supposed to be a two-way connection between the participant's views and the actual course of events. But what about a two-way connection between the participants' views? And what about a solitary individual asking himself who he is and what he stands for and changing his behavior as a result of his reflections? In trying to resolve these difficulties I got so lost among the categories I created that one morning I couldn't understand what I had written the night before. That's when I gave up philosophy and devoted my efforts to making money.


To avoid that trap let me propose the following terminology. Let us distinguish between the objective and subjective aspects of reality. Thinking constitutes the subjective aspect, events the objective aspect. In other words, the subjective aspect covers what takes place in the minds of the participants, the objective aspect denotes what takes place in external reality. There is only one external reality but many different subjective views. Reflexivity can then connect any two or more aspects of reality, setting up two-way feedback loops between them. Exceptionally it may even occur with a single aspect of reality, as in the case of a solitary individual reflecting on his own identity. This may be described as "self-reflexivity." We may then distinguish between two broad categories: reflexive relationships which connect the subjective aspects and reflexive events which involve the objective aspect. Marriage is a reflexive relationship; the Crash of 2008 was a reflexive event. When reality has no subjective aspect, there can be no reflexivity.


Feedback loops can be either negative or positive. Negative feedback brings the participants' views and the actual situation closer together; positive feedback drives them further apart. In other words, a negative feedback process is self-correcting. It can go on forever and if there are no significant changes in external reality, it may eventually lead to an equilibrium where the participants' views come to correspond to the actual state of affairs. That is what is supposed to happen in financial markets. So equilibrium, which is the central case in economics, turns out to be an extreme case of negative feedback, a limiting case in my conceptual framework.


By contrast, a positive feedback process is self-reinforcing. It cannot go on forever because eventually the participants' views would become so far removed from objective reality that the participants would have to recognize them as unrealistic. Nor can the iterative process occur without any change in the actual state of affairs, because it is in the nature of positive feedback that it reinforces whatever tendency prevails in the real world. Instead of equilibrium, we are faced with a dynamic disequilibrium or what may be described as far-from-equilibrium conditions. Usually in far-from-equilibrium situations the divergence between perceptions and reality leads to a climax which sets in motion a positive feedback process in the opposite direction. Such initially self-reinforcing but eventually self-defeating boom-bust processes or bubbles are characteristic of financial markets, but they can also be found in other spheres. There, I call them fertile fallacies—interpretations of reality that are distorted, yet produce results which reinforce the distortion."

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"The ability to maintain discipline and stick to the rules is the hallmark of the experienced successful trader" - Curtis Faith
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I first became aware of Reflexivity from George Soros' Alchemy of Finance book a few years ago, and for some time I thought I'd understood the concept properly, it's only more recently through replaying the relevant parts of that lecture, and by reading more that I now believe I understand it more fully.



The purpose of this thread is for others to learn more about Reflexivity and also to enhance my understanding of it too since through recent Google searches and reading articles it appears to be a misunderstood concept or not understood at all.

As an example as a Google trends chart shows that whilst it is part of human consciousness it is not growing in recognition (at least according to Google);

[Google trends charts like these show the frequency of searches for a specific term (worldwide), in this case reflexivity;]
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The fact that it is a misunderstood concept or not understood at all is in fact exceptionally ironic since the concept of Reflexivity could not exist (or work) without fallibility being a regular feature of human understanding, and I'm quite sure that irony is not lost on George Soros. In fact you could argue the case that because it's generally misunderstood this means it's likely to be closer to the truth than most realise. Furthermore he seems to have difficulty getting the idea across and this is likely to have set up a reflexive relationship between him and those (the majority) that don't get it (and this may have a deleterious impact on his ability to explain it). But I don't want to bewilder people with this so the best way forward is for me to give my explanation of Reflexivity.




We are all part of reality. Included in this reality, clearly, is everything we recognise. So this means physical things, objects, people, mountains etc, it also means things we cannot see such as distant planets, stars etc;

Now let's call these things the objective aspects of reality.

However, we are also thinking beings, so therefore our thoughts are also part of this reality, however since our thoughts do not always correspond to the facts (ie are not reflected in reality) these are best considered as the subjective aspect of reality.

Now our minds really have two modes, or functions, if you like, one is to understand reality, that is cognition or the cognitive function, the other is to influence reality, that is to manipulate or the manipulative function.


In order that we can operate in reality we need to use our cognition in order to try and understand it. Now since we are part of reality, and reality is highly complex, it is not possible to full understand reality.

One way to view reality is that it is a like the inside surface of a circle, since we are part of reality we are inside the circle. Since we are inside it we can only observe one part of it at a time, due to it's inate complexity. In the following diagram reality is represented by the inside surface of the circle. An individual is clearly inside reality but can only try to comprehend part of it (due to it's inate complexity)

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This is where the difficulties begin for us. Since we are inside reality but cannot see all of it at one point our cognition is flawed. Since our cognition of reality is flawed, our understanding of reality is almost always flawed, therefore the actions that we take on the basis of our cognitive function are almost always flawed.

So our understanding of reality is flawed, our cognition is flawed, therefore it follows that our actions based on our cognition are also inherently flawed. Our actions stem from our manipulative function.

Now there is a two way relationship between our cognition of reality and our manipulation of reality.
Reality to cognition is one way and manipulation to reality is another way. Since we are inside the circle we cannot fully understand reality and therefore our actions inside reality (based on imperfect understanding) are wrong and therefore have an impact on reality that we are not capable of fully understanding.



Now Reflexivity is interesting in a number of ways, here's one of them;

The two way relationship between thinking and reality operates via the channels outlined in the diagram, so the cognitive function operates from reality to the mind and the manipulative function operates from the mind to reality. This is capable of setting up a two-way feedback loop between thinking and reality, or put another way the feedback loop is between the subjective and objective aspects of reality. In fact I would argue that this is the default setting. The feedback loop can operate in two directions.

So for example lets say you are a fan of baseball and you are very wealthy. You are a fan of the New York Yankees but you are a businessman and since you are very busy you are unable to follow the New York Yankees all of the time. Lets say that the games you go and see happen to be the ones where they win (but you are aware of the times where they do not win). You are impressed by their skills and you decide to donate $10 million to the club. The club manager wisely uses the $10 million to set up a new system to scout for new talent at the top colleges and universities in the US. This system ensures that the club secures the best new future talent for the club and pays dividends several years down the line since they secure contracts for the best young players. So, lets fast forward 8 years. At this point 2 players in the team have come from the scouting system that your funds enabled. You are very impressed by the the way the team is playing, part of this is down to the athleticism of the play and part of that is down to the 2 players that came from the scouting system that your funds enabled. You are currently happy, business is going well and your baseball team is playing well. You decide to donate a further $10 million. Again the manager wisely sets these funds aside for the scouting school that is now in place to look for new talent. This reinforces the system and leads to further new talent being brought on board.

This is an example of a reflexive relationship between a businessman and his favourite baseball team (A positive feedback loop). He has imperfect understanding of the situation (he is more influenced by the games he watches which are wins, rather than the games he doesn't which are losses). His imperfect understanding led him to donate funds to the club, and had a positive impact on the future play of the team, that in consequence led him to donate further funds to the club after 8 years, which further reinforced his imperfect understanding that the baseball team are a good team and play well.


So we are constantly taking actions based on an imperfect understanding of reality. Our perception is flawed and for the most part it is always flawed.


Lets take the example a step further;


Now the businessman is extremely successful in the business world, he has plenty of funds to play with (hence his dual donations to his favourite baseball team). After total donations of $20 million and 10 years from the initial donation he is cognisant of the fact that he has had a significant impact on the team. He begins to think he can transfer his success in the business world to the world of baseball. He buys a majority shareholding in the baseball club and following a disagreement with the manager he takes over the management of the team, since his understanding of baseball is more limited than the previous manager the baseball team performs poorly, their results suffer, and the baseball team start to lose more games than they win.


So this reflexive relationship, whilst initially a positive feedback loop, has become a negative feedback loop.





A real world example is that of Silver in April 2011, this is a classic example of Reflexivity at work;


[The following is a quote of a post of mine from another forum on 22nd April 2011]

Quoting 
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The blue bands running across this chart show magnitude of volume for each price level, so the further the blue bands are to the right, the higher the volume traded at that price level. It shows volume plotted in profile across price.

Using the volume shown at the bottom of the chart, since the start of the year it appears to have been generally constant and around the start of April has accelerated higher. It looks very bullish. Contrast this to the volume profile, it's trending lower as the price has accelerated from $37 until $46.

We see the same traits in SLV and SIVR.

SLV
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SIVR
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This leads me to think that from $37 upwards, the activity in the market may have been from speculators, johnny come latelys seeking to capitalise on the $50 level. I'm a silver bull, but I would prefer to see these late comers shaken out of the market, and a more consistent price appreciation. Silver has gone up more than 250% in 8 months.


A comment I saw on Zerohedge;




And finally;




"$1,000 OUNCE SILVER IS CONSERVATIVE" (Really?)

Only in a hyper-inflationary event.

There seems to be a detachment from reality here, it reminds me of the wild high estimates of oil during the spectacular 2008 rally.







The reflexive relationship was between the price of silver, the fundamentals of silver and the perception of the participants in the market. Each of the 3 components in that relationship reflexively influenced each other, forming a positive feedback loop, each component reinforced each other.


A symptom of the end of a reflexive process (where it is a positive feedback loop) is a;

Detachment from reality


For those that are unaware, the price of Silver then collapsed since the perception of reality had diverged too far from actual reality.


I am interested in this since as I mentioned before there are a few elements to Reflexivity. I'm deliberately avoiding classifying it since I want to see if someone else understands it at the same level. Once I've developed this further I want to look at a separate topic that is intended to quantify reflexive processes, and from that then develop a new strategy to trade the futures markets.

"The primary thing required to obtain what you want from life, is simply the will to pursue it, and the faith to believe it is possible." - Author Unknown

"The ability to maintain discipline and stick to the rules is the hallmark of the experienced successful trader" - Curtis Faith

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"The primary thing required to obtain what you want from life, is simply the will to pursue it, and the faith to believe it is possible." - Author Unknown

"The ability to maintain discipline and stick to the rules is the hallmark of the experienced successful trader" - Curtis Faith
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This from a paper by C P Kwong,


"Mathematical analysis of Soros’s
theory of reflexivity
"


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And a closed feedback loop diagram illustrating the same thing - understanding and reality are constantly in flux, and it's not sequential or time bound either.

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"The primary thing required to obtain what you want from life, is simply the will to pursue it, and the faith to believe it is possible." - Author Unknown

"The ability to maintain discipline and stick to the rules is the hallmark of the experienced successful trader" - Curtis Faith
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Great job. Very interesting topic.

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Soro's reflexivity theory is pretty solid.

A certain number of participants in the markets who believe solidly in fundamentals maintain stability and many just base their perception of reality based upon price movements... Market is going up, economy must be improving... Buy! Pushes price up... Feedback loop continues rolling as others buy in as their reality is shifted.

Here is the funny part about all of this... In order for markets to maintain stability we need enough people with a solid set of beliefs in fundamentals or there would be parabolic rallies and crashes all the time. Those with strong fundamental beliefs are the force that pushes the market back toward the median and stabilizes it from those who are easily influenced.

If everyone was just trading off technicals and price movement you would see the market making 50%+ moves every few months... In new markets with little history or developed fundamental beliefs like bitcoin you see reflexivity in full force.


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Good reading so far. Can you which book on Soros (written by Soros) would be ideal to start off with? @PositiveDeviant

I have a lot of thoughts/questions pinging through my head right now. I will try and shoot a couple your way

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PositiveDeviant View Post
We are all part of reality. Included in this reality, clearly, is everything we recognise. So this means physical things, objects, people, mountains etc, it also means things we cannot see such as distant planets, stars etc;

Now let's call these things the objective aspects of reality.

However, we are also thinking beings, so therefore our thoughts are also part of this reality, however since our thoughts do not always correspond to the facts (ie are not reflected in reality) these are best considered as the subjective aspect of reality.

Ok, not to get all metaphysical but isn't everything we encounter subjective because we must perceive it internally as opposed to experiencing a 'thing' outside of our subjectiveness? How can we ever encounter objectivity if everything we perceive must be subjective?


Quoting 
Now our minds really have two modes, or functions, if you like, one is to understand reality, that is cognition or the cognitive function, the other is to influence reality, that is to manipulate or the manipulative function.



In order that we can operate in reality we need to use our cognition in order to try and understand it. Now since we are part of reality, and reality is highly complex, it is not possible to full understand reality.

It's been a while since I took my Philosophy courses in college, but this analysis reminds me of Plato's theory on universals versus particulars.

The thought that springs to mind is that objectivity (reality) is the opposite of complex. It is simple, pure and untainted. Objectivity, however is the only constant in the equation. Imo, reality is static, but our perception of reality changes constantly as we are inundated with data and attempt to filter it into information.

To draw on an example that you gave, SLV was physically the same precious metal in 2011 that it is in 2013. It did not have a volatile price because people perceived new layers to its reality. Instead, a change in subjective viewpoints is what lead to the volatile price swings. I cannot understand any way to objectively (read: fundamentally) value SLV or any other product/good/service other than what people are presently paying for it imo.

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