George Soros, the maverick hedge fund manager. has generated significant annual returns, after management fees. His flagship Quantum Fund is revered by investors. Despite the animosity generated by his trading tactics and the controversy surrounding his investment philosophy, Soros has pent decades at the head of the class among the world's elite investors. In 1981, Institutional Investor magazine named him "the world's greatest money manager."

Soros' Philosophy

George Soros is a short-term speculator. He makes massive, highly-leveraged bets on the direction of the financial markets. His famous hedge fund is known for its global macro strategy, a philosophy centered around making massive, one-way bets on the movements of currency rates, commodity prices, stocks, bonds, derivatives, and other assets based on macroeconomic analysis.

Simply put, Soros bets that the value of these investments will either rise or fall. Soros studies his targets, letting the movements of the various financial markets and their participants dictate his trades. He refers to the philosophy behind his trading strategy as reflexivity. The theory eschews traditional ideas of an equilibrium-based market environment where all information is known to all market participants and thereby factored into prices. Instead, Soros believes that market participants themselves directly influence market fundamentals and that their irrational behavior leads to booms and busts that present investment opportunities.

Housing prices provide an interesting example of his theory in action. When lenders make it easy to get loans, more people borrow money. With money in hand, these people buy homes, which results in a rise in demand for homes. Rising demand results in rising prices. Higher prices encourage lenders to lend more money. More money in the hands of borrowers results in rising demand for homes, and an upward spiraling cycle that results in housing prices that have been bid up way beyond where economic fundamentals would suggest is reasonable. The actions of the lenders and buyers have had a direct influence on the price of the commodity.

An investment based on the idea that the housing market will crash would reflect a classic Soros bet. Short-selling the shares of luxury home builders or shorting the shares of major housing lenders would be two potential investments seeking to profit when the housing boom goes bust.

Major Trades

Soros will always be remembered as "the man who broke the Bank of England." A well-known currency speculator, Soros does not limit his efforts to a particular geographic area, instead, he considered the entire world when seeking opportunities. In September of 1992, he borrowed billions of dollars worth of British pounds and converted them to German marks.

When the pound crashed, Soros repaid his lenders based on the new, lower value of the pound, pocketing in excess of $1 billion in the difference between the value of the pound and the value of the mark during a single day's trading. He made nearly $2 billion in total after unwinding his position.

He made a similar move with Asian currencies during the 1997 Asian Financial Crisis, participating in a speculative frenzy that resulted in the collapse of the baht (Thailand's currency). These trades were so effective because the national currencies the speculators bet against were pegged to other currencies, meaning that agreements were in place to "prop up" the currencies in order to make sure they traded in a specific ratio against the currency to which they were pegged.

When the speculators placed their bets, the currency issuers were forced to attempt to maintain the ratios by buying their currencies on the open market. When the governments ran out of money and were forced to abandon that effort, the currency values plummeted.

Governments lived in fear that Soros would take an interest in their currencies. When he did, other speculators joined the fray in what's been described as a pack of wolves descending on a herd of elk. The massive amounts of money the speculators could borrow and leverage made it impossible for smaller governments to withstand the assault.

Despite his masterful successes, not every bet George Soros made worked in his favor. In 1987, he predicted that the U.S. markets would continue to rise. His fund lost $300 million during the crash, although it still delivered low double-digit returns for the year.

He also took a $2 billion hit during the Russian debt crisis in 1998 and lost $700 million in 1999 during the tech bubble when he bet on a decline. Stung by the loss, he bought big in anticipation of a rise. He lost nearly $3 billion when the market finally crashed.

Conclusion

Trading like George Soros is not for the faint of heart or the light of wallet. The downside of betting big and winning big is betting big and losing big. If you can't afford to take the loss, you can't afford to bet like Soros. While most global macro hedge fund traders are relatively quiet types, avoiding the spotlight while they earn their fortunes, Soros has taken very public stances on a host of economic and political issues.

His public stance and spectacular success have put Soros largely in a class by himself. Over the course of more than three decades, he has made the right moves nearly every time, generating legions of fans among traders and investors, and legions of detractors among those on the losing end of his speculative activities.