The Alchemy of Finance was written by renowned investor, George Soros. The book in general attempts to disprove the common assumptions about the market at gives different mental models that you should use when thinking about the market and the subsequent investments you make.
Natural Science vs. Social Science
Soros understood that because social sciences like economics were influenced by thinking individuals whose actions had an impact on the results, they fundamentally varied from nature events.
Although it aspires to be a science, economics lacks objectivity due to the uncertainty created by participants' assumptions. The theory attempts to get around this problem by presuming participants would act rationally.
The end product is an elegant theoretical structure that resembles natural science but does not reflect reality. The assumption of rational behavior is incorrect and leads to great deviation. For instance, it is impossible to know all of the investment options available, thus people base their selections on incomplete information.
Soros developed the idea of reflexivity to deal with this uncertainty rather than try to ignore it. It is characterized as a two-way relationship in which individuals' views also have an impact on events in addition to how they are influenced by them.
The key idea here is that current expectations could significantly affect what happens in the future. Consider a stock; its price is typically determined by the expectations of its investors regarding future earnings. The issuance and buyback of shares, business transactions like M&A, credit ratings and interest rates, or general consumer acceptance, among other things, could all be directly impacted by current valuations in a reflexive manner.
In the following chapters of the book, Soros examines a variety of other reflexive relationships, including the one that exists between foreign currencies and the economy they regulate, the relationship between credit and collateral, where new lending becomes increasingly dependent on collateral values, and the relationship between regulators and the economy they oversee.
Similar to the scientific method, Soros contends that the best approach is to understand what is happening in each unique circumstance and respond appropriately rather than looking for temporary fixes.
Soros claims that he was able to generate higher returns for many years using this methodology in combination with his instinct from years of investment expertise.