What is market reflexivity and how does it affect the crypto space? Let’s take a closer look.
The crypto market is still in its infancy. So is still subject to extreme price swings. The tendency of the market to overreact in response to news and other sources of information can, according to many, be explained by the concept of Market Reflexivity
In the economic space, reflexivity is the idea that market sentiment* is self-reinforcing. It suggests that a feedback loop exists in which the participants’ perception of the market affects the market’s direction and in turn alters participants’ perception. So, a rising market will attract buyers, leading to further price appreciation.
Market sentiment: refers to the collective attitudes of market participants toward the market. The actions that these people take, based on their attitude, influence the market’s direction.
Traditional theories suggest that markets constantly seek equilibrium and all participants are rational and base their decisions on reality. Any fluctuations in the market, like boom and bust cycles, are outliers and prices will eventually return to equilibrium.
Market reflexivity goes against the concept that there is a state of equilibrium.
Reflexivity & George Soros
The theory of reflexivity originates in sociology, but in the economic space, its main proponent is George Soros. Soros believes that reflexivity disproves traditional economic theories that suggest markets constantly seek equilibrium and their participants are rational and base their decisions on reality. He believes that while prices should tend toward equilibrium, reflexivity will often cause prices to move away from the equilibrium.
According to Soros, “In situations that have thinking participants, the participants’ view of the world is always partial and distorted… these distorted views can influence the situation to which they relate because false views lead to inappropriate actions.
…It’s generally recognized that the complexity of the world in which we live exceeds our capacity to comprehend it. Confronted by a reality of extreme complexity we are obliged to resort to various methods of simplification.”
Reflexivity suggests that investors don’t base their decisions on reality but instead on their perception of reality. The actions made as a result of these perceptions impact reality (or the direction of the market) which further affects investors’ perception.
This process is self-reinforcing. The participants’ views influence the course of events, and the course of events in turn influence the participants’ views. This is what creates a feedback loop. It can cause market prices to become detached from reality.
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Disclaimer: NOT FINANCIAL NOR INVESTMENT ADVICE. Only you are responsible for any capital-related decisions you make and only you are accountable for the results.