Source: Qile Club

I. Risks are manageable

Soros achieves investment certainty in a completely different way. Like Buffett and all other successful investors, Soros also measures his investments, but he adopts entirely different investment criteria.

Soros’s key to success lies in actively managing risks, which is one of the four risk mitigation strategies used by investment masters. These four strategies are:

1. Not investing.

2. Reducing risks (Warren Buffett’s primary method).

3. Active risk management (a strategy George Soros excels at).

4. Actuarial risk management.

Most investment advisors strongly recommend another risk mitigation strategy: diversification. However, for investment masters, diversification is absurd and laughable.

No successful investor confines themselves to just one strategy. Some, like Soros, utilize all four of these strategies.

1. No Investment

This has always been one of the optional strategies: invest all your money in Treasury bills (a risk-free investment) and then forget about it.

It may come as a surprise that every successful investor employs this strategy: if they cannot find investment opportunities that meet their criteria, they simply do not invest. Many professional fund managers even violate this simple rule. For example, during bear markets, they shift their investment targets to 'safe' sectors such as utilities or bonds, reasoning that these will fall less than general stocks. After all, you can appear on 'Wall Street Week' and tell an eager audience that you don’t know what to do under the current circumstances.

2. Risk Reduction

This is the core of Warren Buffett’s entire investment strategy.

Like all investment gurus, Buffett only invests in areas he understands—areas where he possesses both conscious and unconscious competence.

But this is not his only principle: his approach to risk avoidance is closely integrated with his investment criteria. He only invests in companies he believes are priced far below their intrinsic value. He calls this his 'margin of safety.'

Under this principle, almost all the work is done before the investment is made. (As Buffett says, 'You make your profit when you buy.') The result of this selection process is what Buffett refers to as a 'high-probability event': an investment with a certainty of return close to (though not exceeding) that of Treasury bills.

3. Active Risk Management

This is primarily a trader’s strategy—and the key to Soros’s success.

Managing risk is vastly different from reducing risk. If you have already reduced the risk to a sufficiently low level, you can go home and sleep soundly or take a long vacation.

Actively managing risk requires constant vigilance over the market (sometimes on a minute-by-minute basis) and calm yet swift action when it becomes necessary to change strategies (such as identifying an error or when the current strategy has run its course).

Soros honed his ability to deal with risk during the Nazi occupation of Budapest, where he faced the daily risk of death.

As a master of survival, his father taught him three survival principles that continue to guide him to this day:

1. Taking risks is not a big deal.

2. When taking risks, do not bet everything you own.

3. Be prepared to retreat in a timely manner.

II. Timely Retreat

In 1987, Soros estimated that the Japanese stock market was on the verge of collapse. He used the Quantum Fund to short stocks in Tokyo while purchasing S&P futures contracts in New York, expecting to make substantial profits.

However, on October 19, 1987, known as 'Black Monday,' his dream turned into a nightmare. The Dow Jones Industrial Average plummeted, marking the largest single-day decline in history. Meanwhile, the Japanese government propped up the Tokyo market. Soros suffered setbacks on both fronts.

"He was engaging in leveraged trading, and the survival of the fund was at risk," recalled Stanley Druckenmiller, who took over Quantum Fund two years later.

Soros did not hesitate. Following his third rule of risk management, he began a full retreat. He offered to sell his 5,000 futures contracts at 230 points, but there were no buyers. At 220 points, 215 points, 205 points, and 200 points, it was the same—no takers. Finally, he sold between 195 and 210 points. Ironically, the selling pressure disappeared as he exited, with the futures closing higher that day.

Soros had lost all the profits he made for the entire year. However, this did not trouble him. He admitted his mistake, acknowledged that he had misread the situation, and, as with any error (whether minor or existential like this one), he adhered to his risk control principles. The only difference this time was the size of the position and the low liquidity in the market.

First and foremost, survival. Everything else is secondary. He did not freeze, hesitate, stop to analyze, reflect, or consider holding onto his position in hopes of a turnaround. He withdrew without hesitation.

Soros's investment approach involved forming a hypothesis about the market and then 'listening' to the market to assess whether his hypothesis was correct or incorrect. In October 1987, the market told him he had made a mistake—a fatal one. When the market disproved his hypothesis, he no longer had any reason to hold his position. As he was losing money, his only option was to retreat quickly.

The stock market crash of 1987 cast a shadow of death over Wall Street for months. "Afterward, every manager I knew who suffered from the crash became almost numb," said Druckenmiller. "They all became disoriented, and I am referring to legends in the industry."

As the outstanding hedge fund manager Michael Steinhardt put it: "That autumn was so disheartening that I didn't even want to continue. Considering I had warned earlier in the year (suggesting caution), those losses hurt even more. Maybe I had lost my judgment, maybe I wasn’t as sharp as before. My confidence wavered. I felt isolated."

But Soros was different. He was one of those who suffered the greatest losses, yet he remained unaffected.

Two weeks later, he returned to the market, aggressively shorting the US dollar. Knowing how to handle risk and adhering to his own rules, he quickly moved past the disaster, leaving it behind as history. Overall, Quantum Fund still achieved an annual return rate for that year.

Three: Breaking Free from Emotional Control

One distinctive aspect of the mental state of investment masters is their ability to completely free themselves from emotional control. No matter what happens in the market, their emotions remain unaffected. Of course, they may feel happy or sad, annoyed or excited, but they have the ability to quickly set these emotions aside and clear their minds.

If you are swayed by personal emotions, you are extremely vulnerable in the face of risk. Investors who are overwhelmed by emotions (even if, logically, they know exactly what to do when things go wrong) often hesitate, endlessly pondering what to do next, and to relieve the pressure, they usually retreat (often at a loss).

Buffett has achieved the necessary emotional detachment through his investment methodology. He focuses on the quality of enterprises. His only concern is whether his investments consistently meet his standards. If they do, he feels pleased, regardless of how the market evaluates them. If a stock he holds no longer meets his criteria, he sells it, irrespective of its market price.

Warren Buffett pays no attention to market trends; it’s no wonder he frequently says he wouldn’t care even if the stock market were closed for ten years.

Four: "I can make mistakes too."

Like Buffett, Soros' investment approach helps him emotionally detach from the market. However, beyond the confidence shared by both him and Buffett, his ultimate safeguard lies in “constantly reminding anyone patient enough to listen that he can also make mistakes.”

He makes an assumption about how and why a particular market will change and then invests based on that assumption. The very term “assumption” implies a highly experimental stance, making it unlikely for someone holding such a position to “marry their position.”

However, just as he once publicly predicted that the '1987 stock market crash' would begin in Japan rather than the United States, there are times when he expresses certainty about the next move of 'Mr. Market.' If reality does not align with his expectations, he can be genuinely surprised.

Soros’ firm belief that he, too, is prone to error overrides all other beliefs and forms the foundation of his investment philosophy. Therefore, when the market proves him wrong, he immediately acknowledges the mistake. Unlike many investors, he never holds onto positions under the pretext that 'the market is wrong.' He exits promptly.

As a result, he can extricate himself completely and without hesitation from troublesome situations. In the eyes of others, he appears to be an unemotional ascetic.

4. Actuarial Risk Management

In fact, the fourth risk management approach operates in much the same way as an insurance company.

An insurance company has no idea whether it will need to pay out on a life insurance policy when it issues it. The payout might be required the next day or perhaps not for another 100 years. This uncertainty is immaterial to the company.

An insurance company does not attempt to predict when you will die, when your neighbor’s house will be burned down or burglarized, or any other specific event it has insured against.

The method by which insurance companies manage risk is by underwriting a large number of policies, allowing them to predict with considerable accuracy their average annual payout amount.

By focusing on general trends rather than individual events, insurance companies can set premium levels based on the average expected value of claims. Thus, your life insurance premium is calculated based on the average life expectancy for individuals of your gender and your health status at the time of application. The insurer does not make judgments about your specific life expectancy.

The professionals who calculate premiums and assess risk levels are known as actuaries, which is why I refer to this risk management strategy as 'actuarial risk management'.

This method relies on an average figure referred to as the 'expected value of risk.'

While investment experts may use widely accepted terminology, what they truly focus on is the expected average profit margin.

For instance, if you bet $1 on a coin toss where heads wins, your chances of winning or losing are both 50%. Your expected average profit is zero. If you toss the coin 1,000 times, betting $1 each time, your total funds at the end should be roughly the same as when you started (provided an unusual streak of tails doesn’t bankrupt you midway).

A 50% chance is essentially meaningless, especially after you have paid the transaction fee.

However, if your chances of winning and losing are 55% and 45%, respectively, the situation changes. Your total profits in consecutive events will exceed your total losses because your expected average profit has increased—every dollar you invest is expected to yield a return.

Gambling, Investment, and Risk

Gambling: Noun – A risky action; any event or thing involving risk. Transitive Verb – To take a substantial risk in the hope of gaining significant rewards. Intransitive Verb – To bet or stake on an event with specific occurrence probabilities.

People often equate investment with gambling, and for good reason: essentially, actuarial science is about 'playing the odds.'

Another reason (though a poor one) is that too many investors enter the market with a gambling mentality – 'hoping for substantial gains.' This mindset is particularly common among first-time traders in the commodities market.

To illustrate the similarities between the two, let’s consider the difference between a gambler and a professional gambler.

A gambler plays games of chance for money – hoping for substantial gains. Since he rarely wins, his primary reward is often just the thrill of playing the game. Such gamblers sustain the gambling industries and lotteries in Las Vegas, Monte Carlo, Macau, and around the world.

The gambler places himself at the mercy of the 'gods of luck,' no matter how benevolent they may seem. Their earthly representatives, however, live by the motto 'never be kind to fools.' As a result, to quote Buffett:

When people engage in financial transactions that appear to involve minor losses, wealth transfer occurs, and Las Vegas thrives on this very phenomenon.

In contrast, a professional gambler knows the odds of winning and losing in the game he plays, and only places bets when he has a significant advantage. Unlike weekend gamblers, he does not rely on the roll of the dice. He has calculated the probabilities of winning and losing in the game, so over the long term, his gains will inevitably outweigh his losses.

He approaches the game with the mindset of an insurance company issuing policies. What he values is the expected average profit.

He has his own system—just like an investment guru. And part of this system is sufficient to keep him ahead: selecting games that are statistically profitable over the long term.

You cannot change the odds of winning or losing in poker, blackjack, or roulette, but you can calculate the probabilities to determine whether it's possible to play under conditions where the expected average profit (probability) favors you.

If it’s not possible, then don’t play. Fool!

The secret of a professional gambler goes beyond calculating probabilities: they seek out gambling opportunities where the odds are inherently tilted in their favor.

I have a friend who is a member of Alcoholics Anonymous. Once, he took a 60-minute ferry ride from home to run errands and, on his return trip in the evening, he noticed a group of alcoholics sitting around a table at the stern of the boat, enjoying beer purchased from the onboard bar.

He pulled up a chair, took out a deck of cards from his bag, and said, “Anyone want to play a couple of rounds?”

Professional gamblers rarely buy lottery tickets.

Professional gamblers do not actually gamble. They do not 'take great risks with the hope of obtaining huge rewards.' Instead, they repeatedly make small investments that are mathematically guaranteed to yield returns. Investment is not gambling. However, the actions of professional gamblers at the poker table share similarities with those of investment gurus in financial markets: both understand risk mathematics and only put money on the table when the odds are in their favor.

Actuarial Investment

When Warren Buffett first started investing, his approach was significantly different from what it is today. He adopted the method of his mentor, Benjamin Graham, whose system was based on actuarial principles.

Graham's goal was to purchase common stocks of medium-sized enterprises that were undervalued, 'if their price was two-thirds or less of their intrinsic value.'

He solely relied on analyzing publicly available information to assess the value of a business, with his primary source of information being the company's financial statements.

The book value of an enterprise serves as a fundamental measure of its intrinsic value. Graham's ideal investment targets were companies whose market prices were significantly lower than their liquidation value or asset realization amount.

However, there could be various reasons why a stock price is low. Perhaps the relevant industry is in decline, the management team is incompetent, or a competitor has captured all the customers of the business with a superior product, among other factors. Such information cannot be found in the company's annual reports.

By merely analyzing data, Graham would not know why a stock was cheap. As a result, some of the stocks he purchased became worthless due to corporate bankruptcies; some rarely deviated from his purchase price; and others recovered to or exceeded their intrinsic value. Graham could rarely predict which scenario would occur for any given stock.

So how did he make money? In fact, he would buy dozens of such stocks, ensuring that the profits from the rising stocks far outweighed the losses from the others.

This is the actuarial risk management approach. Just as an insurance company is willing to provide fire insurance to all members of a specific risk category, Graham was also willing to purchase all stocks of a particular type.

For instance, the insurance company does not know whose house will catch fire, but it is well aware of the probability of compensating for fire damage. Similarly, Graham did not know which of his stocks would rise, but he knew the percentage of stocks that would generally appreciate in his portfolio.

An insurance company must sell insurance at an appropriate price to make a profit. Similarly, Graham must purchase stocks at the right price; if he pays too much, he will lose money instead of making it.

The actuarial method certainly lacks the romantic appeal of investment gurus—those magical figures who only buy stocks that are sure to rise. However, more successful investors have used this method than any other. Its success depends on selecting certain types of stocks, combining them, and ensuring that the average expected profit is positive.

Buffett started in this way, and to this day, he still uses this method when engaging in arbitrage trading. It also contributed to Soros's success and forms the basis of most commodity trading systems.

The average expected profit for investors is equivalent to an insurance company’s actuarial table. Identifying a set of specific investments with a positive average expected profit under conditions of repeated long-term purchases forms the foundation for designing hundreds of successful investment and trading systems.

Risk and Return

Most investors believe that the greater the risk you take, the higher your expected profit will be.

However, investment masters do not believe that risk and return are equivalent. They invest only when the average expected profit is positive, so their investment risk is minimal or nonexistent.

Editor/Jayden