Part of Sentiment as Substrate by Adrian Morris
Chapter 3The Role of Reflexivity in Markets
Outside of finance, Reflexivity refers to a self-perpetuating loop in which cause and effect shape outcomes and beliefs, with each recursively feeding the other. Within this dynamic, human beings are observers, creating a self-referential cycle in which the act of interpreting reality feeds back into our understanding of reality.
While first-cause framing explains the genesis of market activity, it does not account for why market moves appear self-reinforcing, often accelerating, seemingly validating the very beliefs that produced them. Reflexivity addresses what we often see manifested in price action where rising prices attract buyers whose activity then pushes prices higher, and the resulting move appears to validate the very judgment that initiated it. This describes how what begins as a sentiment leads to action, the action in turn becomes a market signal, and the signal reshapes incentives for subsequent participants, perpetuating the feedback loop. If “first-cause” explains how markets begin, then reflexivity explains how they gather momentum.
The implication is that markets do not merely reflect information, but that prices and valuations alter perceptions.1 This is a relationship that may complicate cause and effect, but does not change the fact that sentiment initiates while reflexivity propagates. In a reflexive system, feedback begins after someone commits capital, requiring only that market participants treat price as meaningful and then act on that meaning. When they do, sentiment produces the very conditions and artifacts that observers retroactively label as “fundamentals”. With human actors initiating, and feedback loops converting decisions into new scenarios, price actively reshapes the very environment it describes.
Some might object that reflexivity is the source of sentiment, arguing that rising prices create the very bullishness that drives them. But this confounds effect with cause. Asset prices do not move spontaneously; they are the kinetic result of capital commitment that necessitates antecedent belief. Reflexivity may modify or accelerate that belief, but a feedback loop, by definition, presupposes an input and cannot not self-initiate. Therefore, to claim that prices increase unambiguously because they increase, is a tautology2 that ignores the first cause: human sentiment. Reflexivity describes how it flows through the system, but the mechanism of transmission is not the mechanism of origin. This reveals market sentiment as the primary input, not a reaction, making reflexivity the mechanism by which subjective expectations become market reality.