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Alchemy of Finance
 
This is a marvelous book to give to people who have an exaggerated perception of their own investment talents. By page 10, they will probably feel overwhelmed. It is unquestionably a difficult read, written by a man who views himself more as a philosopher than a money manager. However, if you are willing to make the effort, it will be time well spent. George Soros is that rare commodity: a truly original and brilliant thinker, and one who is self-critical without being falsely humble.

While most great investors are able to simplify a complex world, Soros is able to make the world more complex and still understand it. His is an approach to be admired, but not one to be easily followed. The value of Soros's book is not in his day-to-day investment approach, but in his economic and market insights.

Soros's basic premise is reflexivity: Events create expectations which influence the financial markets; the markets, in turn, then influence these events. For example, a strong stock market based on the perception of a strong economy will boost the confidence of investors and consumers. This confidence will result in greater purchases by individuals which, in turn, will help to boost the economy.

Soros believes that reflexivity applies to the credit, currency and stock markets. He also contends that regulation is subject to the process of reflexivity, and that its relative popularity tends to run in tandem with the bust-and-boom cycles of the financial markets — the greater the bust, the greater the regulation (and vice versa). In addition, he believes that free markets, left to their own devices, will not tend toward equilibrium.

The most interesting conclusion Soros draws from his "real-time experiment" is that the market is an excellent early warning system for potential economic catastrophes. By reflecting the fears of investors, the market encourages the powers-that-be to correct the underlying problems before they become unmanageable. In this regard, the market appears to worry constantly about possibilities that never seem to happen when, in fact, the market's concerns help to forestall these potential catastrophes.

Soros also professes to be an anti-contrarian, preferring to bet with the crowd rather than against it. Since "events tend to reinforce prevailing expectations most of the time," he argues, the contrarian only wins at the elusive turning points.

(Editor's Note: Certainly, at the end of a bull or bear market, expectations do become temporarily self-fulfilling, as described earlier. However, playing the trend is not an approach that the individual investor should rely upon. All things considered, you should try to be a long-term investor focusing on the less popular, since these are the investments that are most likely to be undervalued.)

Soros is also wary of what he perceives to be the popularity of the contrarian approach. (Ed. Note: By definition, however, contrarian thinking cannot become the consensus viewpoint. Its apparent popularity among investors is usually not reflected in their actions, recalling the old saying: Do as I say, not as I do.)

Suggestion: Go to The Money Masters