1. The market always shows some deviations; 2. The market can influence its expected events; These two propositions combine to explain why the market often seems to be able to correctly predict future events. Based on the participant's bias, we can try to establish a model of the interaction between the participant's point of view and the situation he participates in. The difficulty is that the participant's point of view is part of the situation in which he participates. To study such a complicated situation, simplified methods must be adopted. Participants' prejudice is such a simplified concept. Now I want to go one step further and introduce the concept of prevailing prejudice. There are many market participants, and their views are bound to be different. Many cancel each other out, and the rest is what I call "mainstream prejudice." This assumption does not apply to all historical processes, but it does apply to the stock market and other markets. The sum of many viewpoints is possible because they intersect at the same point, that is, the stock price. In other historical processes, participants' views are too scattered to be combined, and the mainstream prejudice can only be a symbolic concept, and other models may have to be introduced. However, in the stock market, the prejudice of participants has been reflected in stock trading. Other things being equal, positive deviation leads to price increase and negative deviation leads to price decrease. Therefore, mainstream prejudice is an observable phenomenon. Other factors are different, so we need to know more about "other factors" to build our model. Here I will introduce the second simplified concept. Suppose there is a "basic trend", whether investors are aware of it or not, it will affect the change of stock price, and its influence and degree depend on the views of market participants, which is by no means static. Based on these two concepts, we can imagine the movement trend of stock price as a combination of "basic trend" and "mainstream deviation". How do these two factors interact? Please recall the two functional relationships mentioned earlier: participation function and cognitive function. The basic trend affects the cognition of participants through cognitive function, and the changes caused by cognition affect the situation through participation function. In the stock market, the stock price is the first to be affected, and the change of stock price in turn affects the bias and basic trend of participants at the same time. There is a reflexive relationship, and the stock price depends on two factors-basic trend and mainstream deviation-which are in turn influenced by the stock price. There is no constant relationship between stock price and the interaction between these two factors: the independent variable in one function becomes the dependent variable in another function. If there is no constant relationship, a balanced trend will be impossible. The order of market events can only be explained as a historical change process, and no variable-stock price, basic trend and mainstream deviation-can remain unchanged. In a typical market event sequence, three variables first reinforce each other in one direction, and then reinforce each other in another direction. The alternation of prosperity and depression is the simplest and most familiar model. First, define several concepts. If the stock price changes strengthen the basic trend, we call this trend self-reinforcement, and when they act in the opposite direction, it is called self-correction. The same terminology applies to mainstream prejudice, which may be self-reinforcing or self-correcting. It is very important to understand the meaning of these terms. If the trend is strengthened, it will accelerate. When the deviation is strengthened, the difference between the expected change and the actual change of the future stock price will expand. On the contrary, when it corrects itself, the difference narrows. As for the change of stock price, we simply describe it as rising and falling. When the mainstream bias pushes the price up, we call it positive. When it acts in the opposite direction, it is called negative. The rising price change is strengthened by positive deviation, while the falling price change is strengthened by negative deviation. In a boom/bust sequence, we can expect to find at least one stage, in which the rising price change is strengthened by positive deviation, and one stage, in which the falling price change is strengthened by negative deviation. At the same time, there must be one thing. At this point, the basic trend and mainstream prejudice have been combined to reverse the direction of the stock price. It is now possible to establish a preliminary model of the alternation of prosperity and depression. First of all, suppose there is a basic trend that has not been realized-although the possibility of mainstream bias that is not reflected in the stock price cannot be ruled out, that is to say, the mainstream bias is negative from the beginning. At first, market participants are aware of the basic trend, and this change in understanding will affect the market price of stocks (through investment decisions). Changes in stock prices may or may not affect the basic trend. In the latter case, the problem ends here and there is no need to discuss it again. In the former case, we have entered the starting point of the self-strengthening process. The trend of strengthening may be biased towards the mainstream in two directions, leading to further acceleration or revision of expectations. If it is the latter, this basic trend may continue or terminate after the stock price changes are corrected; If it is the former, it shows that a positive bias has developed, which will lead to a further rise in the stock price and an accelerated development of the basic trend. As long as this prejudice can reinforce itself, people's expectations will rise faster than the stock price. The basic trend is increasingly influenced by stock prices. At the same time, the rise of stock price is increasingly supported by mainstream prejudice, which makes the basic trend and mainstream prejudice slide to an extremely fragile state at the same time. Finally, the price change cannot maintain the expectation of mainstream deviation, so it enters the correction process. Disappointed expectations have a negative impact on the stock price, and unstable stock price changes weaken the basic trend. If the basic trend depends too much on the change of stock price, then the correction may become a complete reversal. In this case, the stock price falls, the basic trend reverses, and the expected decline is even faster. In this way, the process of self-reinforcement begins in the opposite direction, and eventually, the decline will reach the limit and reverse itself again. Usually, the process of self-reinforcement will undergo moderate self-correction in the early stage. If the revised trend continues, this bias will have a chance to be strengthened and consolidated, and it will not be easily shaken. When this process continues, the correction behavior will gradually decrease, and the risk of trend peak reversal will increase. I have outlined a typical boom/bust sequence process above, which can be described by two curves in the same direction. One represents the stock price and the other represents the earnings per share. People will naturally regard the yield curve as a yardstick of basic trends, and the gap between the two curves is a sign of mainstream deviation. The specific relationship is of course much more complicated. The yield curve not only integrates the basic trend, but also integrates the influence of stock price on this trend. The deviation of the mainstream is only partly reflected in the gap between the two curves, and the other part is reflected in the curve itself. Because the phenomena they represent can only be partially observed, these concepts are extremely difficult to operate, which is why observable and quantifiable variables are chosen-although, as will be mentioned later, the quantification of earnings per share is quite chaotic. For present purposes, we assume that the "basic factors" that investors are interested in can be properly measured by earnings per share. The following figure (Figure 2- 1) shows the typical trends of these two curves. At first, the recognition of the basic trend will lag behind to some extent, but the trend is strong enough, and it is shown in earnings per share (A-B). After the basic trend was recognized by the market, it began to be strengthened by rising expectations (B-C). At this time, the market is still very cautious, and the trend continues to develop, sometimes weakening and sometimes strengthening. This test may be repeated many times, and only one time (C-D) is marked in the figure. Therefore, confidence begins to swell, and short-term setbacks in earnings will not shake the confidence of market participants (D-E). The market can't continue to maintain this trend (E-F) because the expectation is excessively inflated, which is far from the reality. Fully aware of the deviation, expectations began to decline (F-G). The stock price lost its last support and the plunge began (G). The reversal of the basic trend has strengthened the downward force. Finally, the excessive pessimism was corrected and the market was stabilized (H-I). What needs to be emphasized is that this is only a possible path, and it is the result of the interaction between a basic trend and a mainstream bias. There may be more than one basic trend in reality, there will be various subtle differences in internal bias, and the sequence of events may have very different paths. A few words can be said about the theoretical structure of the model. We are interested in the interaction between the participant's deviation and the actual event process, but the participant's deviation will not appear directly in the model, and both curves are the performance of the actual event process. The mainstream bias is partly integrated into these two curves, and partly reflected by the differences between them. The main value of this structure is that it uses quantifiable variables. The stock price acts as a convenient representative of the situation related to the deviation of the participants. In other historical processes, there are also cases in which there are internal relations with participants' cognition through cognitive function and participation function, but it is much more difficult to distinguish and quantify them. The convenience of measurement makes the stock market a very effective laboratory for studying reflexivity. Unfortunately, the model only provides a partial explanation of how to determine the stock price. The basic trend is just a placeholder to indicate the change of "basic factors". In this concept, the basic factors are not defined, and even the problem of how to measure the basic factors is avoided. Income, dividends, asset value and free cash flow are all related, and other measures are no exception. However, the relative weight given to each scale depends on the judgment of investors, that is, it is subject to their prejudice. Of course, earnings per share is a useful concept, but it will cause more problems, which has been debated by stock market analysts for a long time. Fortunately, this difficulty does not prevent us from continuing to develop the theory of reflexivity. Even if we know nothing about the basic factors, we can still make some valuable generalizations. The first generalization is that the stock price will definitely have an impact on the basic factors (no matter what), thus producing a boom/bust model. Sometimes, this connection is direct, and I will give a few examples later, but in most cases, this connection is indirect, and it is often achieved through political procedures such as taxation, supervision or changing attitudes towards savings and investment. Even if the basic trend remains unchanged, there is likely to be a reflective relationship between stock prices and mainstream deviations. However, this connection is only interesting when it comes to basic trends. Assuming that the basic factors have not changed, the mainstream deviation may be corrected soon, which is exactly what we observe in the daily changes of the stock market. It should be appropriate to treat this deviation as noise and ignore it. The school of full competition theory and basic factor analysis of securities did just that. In contrast, when the basic factors are affected, we have to think that this deviation is seriously distorted, because it has caused a process of self-strengthening/self-lowering, in which the stock price, basic factors and participants' views have changed beyond recognition. The second generalization is that participants' cognition of basic factors must contain some defects, which may not be obvious at first, but will be shown later. At this time, the reversal stage of mainstream bias will begin. If the deviation changes and reverses the basic trend, the trend of self-reinforcement begins to move in the opposite direction. Where are the defects? How and when did it appear? This is the key to understanding the boom/bust model. The previous model is based on these two generalizations. Of course, the model is extremely rough. Its value lies in that with the help of this model, we can distinguish the decisive characteristics of typical boom/bust sequence processes. These include: the trend that investors are not aware of, the beginning of self-strengthening process, the test of success, the increasing confidence, the widening gap between reality and expectation, the cognitive defects of investors, the climax of the market and the reverse self-strengthening process. Only by distinguishing these characteristics can we understand the changes of stock prices. However, we cannot expect to get more from an initial model. In any case, the reflexive model can't replace the basic analysis, and its role is limited to providing the components that the basic analysis lacks. In principle, these two methods can be reconciled. The basic analysis tries to establish how the potential value is reflected in the stock price, while the reflexivity theory explains how the stock price affects the potential value, one is a static picture and the other is dynamic. Although it can only partially explain the movement of stock prices, this theory may still be very useful for investors, because it clarifies a market relationship that other investors fail to understand. Investors have only limited funds to dispatch and limited information to operate. They don't need to be know-it-all, as long as their understanding is slightly better than others, they can get the upper hand. Although the professional knowledge of securities analysis has its own strengths, it fails to hit the key issues that investors care about. Reflexivity theory is good at understanding and distinguishing historical price changes, so it can go straight to the core of the problem. In my own investment career, the above model has proved that it can bring considerable return on investment. On the surface, this model is so simple that it conforms to people's usual stock market model, so I think every investor should not be unfamiliar with it. However, the actual situation is far from this. Why is this happening? In my opinion, this situation is largely caused by the conceptual errors of the participants. This concept originated from classical economics and can be traced back to the theoretical structure of natural science. They stubbornly believe that the stock price is a passive reflection of some basic realistic factors, rather than a positive component in the historical process. We have seen that this is absolutely wrong, and it is worth noting that people have not clearly realized this. Of course, investors do understand the market processes I pointed out and respond to them. The only difference is that they are one step behind. It is my advantage to choose a suitable model and pay attention to finding the key features that determine the shape of the price curve. The first time I systematically applied this model was in the late 1960s. During the hot period of group enterprises, it helped me make money in both prosperity and depression. The key reason for the upsurge of group enterprises is various misunderstandings of investors. Investors only know that the evaluation of earnings per share has improved, but they have not seen through the way to achieve growth. Many companies have mastered the method of increasing revenue through acquisition. Once the market starts to respond positively to their performance, things will be much simpler, because they can use their overvalued stocks as payment tools when acquiring other companies. The principle of this move is as follows: first, suppose that all companies have achieved the same internal profit growth, but the shares of the acquired company are sold at twice the price-earnings ratio of the acquired company. If the size of the acquired company can be doubled, the earnings per share will jump by 50%, and the growth rate of the enterprise will also increase accordingly. In practice, the early group enterprises were all those enterprises that achieved high internal growth rate and thus won high P/E ratio in the stock market. Several pioneers are high-tech companies with strong national defense background, and their managers realize that their past historical growth rate cannot be maintained indefinitely, such as Tex-tron, Teledyne, Ling-Temco-Vught (later LTV) and so on. They began to buy more companies with average market (P/E ratio), but with the acceleration of earnings per share growth, their P/E ratio rose instead of falling. Their success attracted imitators, and later even the most humble companies were able to trade at a high P/E ratio in the market with the help of acquisition mania. For example, Ogden Company, the main part of its income comes from scrap metal trading, however, its stock is sold at a price of 20 times its peak income. Finally, a company can even win a high P/E ratio as long as it promises to make an acquisition and succeed. Managers invented special accounting treatment techniques to enhance the impact of acquisition, and they also introduced some new treatment methods to the acquired company: simplified operation, asset sale and general manipulation of net income. However, compared with the impact of acquisition on earnings per share, these methods are dwarfed. Investors reacted as if Indians had seen a ghost. At first, each company's record was based on its own value. However, the group enterprise is gradually recognized as a special department, so a group of new investors, the so-called quick profit fund managers or "day traders", have established a special close relationship with the managers of the group enterprise, and the two sides have opened a hotline. Group enterprises directly deposit the so-called "stocks" with investors, and finally they can control the stock price and income almost at will. The development of events follows the path I described in the model. The price-earnings ratio soared, and the real market finally could not bear the expected burden. Although the game continues, more and more people have realized that it is still a wrong idea to support the confidence of market prosperity. The acquisition scale is getting bigger and bigger, otherwise it will not be enough to maintain the growth momentum until its scale reaches its limit. The climax of the whole process is Soul Steinberg's acquisition of Chemical Bank, which was countered by the bank and failed. The stock price began to fall, and the downward trend entered the process of self-strengthening. The favorable impact of acquisition on earnings per share disappeared, and new acquisitions became unwise, exposing the internal problems covered up during the external high-speed growth period. The earnings report revealed an unpleasant surprise. Investors woke up from their dreams and the managers of the company felt unsafe. The exciting success has passed, and no one wants to take care of the trivial matters of daily management. The economic recession has aggravated this dilemma. Many arrogant group enterprises closed down, investors made the worst plans, and several such cases did happen. The actual performance of other companies is better than market expectations. Finally, the situation in the stock market gradually stabilized. The prosperity of group enterprises is particularly suitable to prove my original model because its "basic factors" are easy to quantify. Investors are valued according to the earnings per share report. No matter how meaningless the numbers in the chart are, they still provide graphs that are very consistent with my theoretical prototype (see Figure 2-2, Figure 2-3 and Figure 2-4). In my efforts to understand and grasp the prosperity/depression process of group enterprises, my most successful example is the investment operation of real estate investment trusts, the so-called REITs. This is a special form of legal person organization authorized by legislation. Their key feature is that they can be exempted from paying corporate tax when distributing income, provided that all income is distributed in full. Until 1969, this opportunity, which was born with the authorization of legislation, was not well utilized to a great extent. Since then, a large number of real estate investment trusts have been established. I witnessed their establishment. As I have just experienced the rise and fall of the group enterprise boom, I realize the potential of this kind of company to launch a boom/bust sequence process in the market. For this reason, I published a research report, the main contents are as follows: Case analysis of mortgage trust (1970 February).