How To Speculate: A Billionaire's Perspective


Release Date: November 30, 1999
© 1999 Macroknow Inc. All Rights Reserved.

So you want to get rich. Then speculation in financial markets may be the right strategy for you. But, before dabbling in speculation, you'd better master what it takes to come out ahead. This column is designed to help you get started.

First, you must study the works of the master speculators -- like George Soros, billionaire financier and philanthropist. Soros is the author of The Crisis of Global Capitalism [Open Society Endangered] (PublicAffairs™, New York, 1998)1. His book is full of in-your-face insights. Here are two examples: "Everybody must look out for his or her own interests and moral scruples can become an encumbrance in a dog-eat-dog world" and "people who are not weighed down by any consideration for others can move around more easily and are likely to come out ahead."

The principle of amorality

If you want to get rich, the first thing you must understand is that "financial markets are not immoral; they are amoral." Soros cants this principle again and again -- but he warns that amorality has its price.

The principle of amorality appears to be grounded in the principle of "fallibility." Fallibilism was promoted by the philosopher Karl Popper in The Open Society and Its Enemies. Like Popper, Soros believes that no one is capable of knowing the absolute truth. And, if truth is beyond human reach, then no one can tell what is ultimately right and what is ultimately wrong.

"Everybody must look out for his or her own interests and moral scruples can become an encumbrance in a dog-eat-dog world" -- George Soros

For speculators, fallibilism has its reward. The reward is called "reflexivity." Learn how to seek it, and you can, like Soros, generate huge profits. The truth may be beyond your reach, but not riches.

What is "Reflexivity"

What is "reflexivity" you ask? According to Soros, it is the two-way interaction between thinking and reality. Reality and thought are not the same thing; they interact and they influence each other. Perfect truth occurs when reality and thought coincide perfectly. But, how often does this happen? Speculators exploit the gap between reality and thought, especially when it is extreme, to make huge profits. How? They exploit the present when the present reflects other people's fallible expectations about the future. Let me explain.

The secret meaning of "time" and how to exploit it

The secret meaning of time was first revealed by St. Augustine in Confessions. What is this secret? Neither the past nor the future exists. Only the "immediate vision" of things present exists. Augustine taught that the past is the present memory of things past, and the future is the present expectation of future things. A blunt consequence of this theory of time is this: To manipulate the present, you must manipulate the expectation of future events.

Augustine's insight unconceals how reflexivity in financial markets allows clever speculators to get rich. The price of a share of common stock is its present value. This is the sum of two kinds of discounted cash flows: The quarterly dividends the investor expects to receive until the stock is sold, and the price he or she expects to pocket when the stock is sold. Both cash flows are expected future values, and both depend on future earnings per share. In other words, the price of a stock is conditioned by present information about future expected prices and earnings, and these interact continuously. Therefore, to exploit a stock's price, you must exploit the fallible present expectation of its future "fundamentals." But how? Well, this is where the boom/bust process comes in.

According to Soros, the "ideal" boom/bust process has eight stages. The boom process is initiated when financial values become "reflexive." That is when expected earnings inflate stock prices and inflated stock prices inflate the expected earnings, in a mutually "self-reinforcing" way. This vicious cycle creates an increasing gap between price expectations and reality. When the gap becomes incredible, a "self-correction" process sets in. The self-correction can accelerate and get out of control. When this happens, the bust culminates with a catastrophic price meltdown or crash. But don't worry. Other people's problems can be your opportunity. You cannot be held responsible for other people's fallibility!

How good is Soros' model? It is very good. But don't take my word for it. Take a look at how the price and EPS data for fallen stars around the globe have unfolded and judge for yourself.

How to benefit from the boom/bust model

Can you benefit from Soros' model? Sure, with a caveat: Models are fallible. And what strategies can be gleaned from the model? Here are just a few. Use them at your own risk. For Soros’ comprehensive model and analysis, you must consult Soros' works.

  • Seek stocks whose price expectations and fundamentals are "reflexive." This is an acquired reflex (no pun intended). You must be able to pick up "the scent" of a self-accelerating process that is waiting to crash. In this connection, it is amusing to note Soros' description of his own physiological response to reflexivity: "I used to get particularly excited when I picked up the scent of an initially self-reinforcing but eventually self-defeating process. My mouth began to water as if I was one of Pavlov's dogs."
  • Always look for your own interest. Be amoral. This way, you can never be too encumbered. There is an important corollary to this: You must "play by the rules."
  • Focus exclusively on maximizing your profits. Here, your thinking must become calculative and focused on weighing risks versus rewards. You can profit on the upside if you buy stocks in the early stages of the boom process, then sell them before they peak. You can also profit handsomely on the downside if you buy the most valuable parts of the crashed company late in the bust stage, at rock bottom prices, then wait until prices recover. In the latter case, it helps if you are a rich financier or own a big bank -- or if your business is vulture capital.

One final note. The current spectacular boom in U.S. stocks will be followed by a nasty bust, perhaps a global crisis. So, maximize your profits while you can, but prepare for the darkness that lurks around the corner.



1 George Soros, The Crisis of Global Capitalism: Open Society Endangered. New York, NY: Public Affairs, 1998.