Breaking Down Market Noise and How to Avoid It
Posted by Ocean Wealth
In 1986, American economist Fisher Black developed a landmark theory of pricing known as “noise.” This term describes things such as hype, inaccurate ideas, and inaccurate data. Black viewed noise as being the opposite of information and that there was a disproportionate amount of trading happening based on it.
You might be thinking to yourself, “Isn’t all trading based on these kinds of speculations?” While trading itself is somewhat speculative at its core, it’s based on careful, fundamental analysis and research that leads to more well-informed decisions. Noise traders, on the other hand, are more reactionary. They rely on trending news, sudden surges , nd declines in prices, and word of mouth that's not based on any tangible evidence.
Market noise can lead to knee-jerk trading that comes from haste rather than carefully analyzed data over time. It’s those irrational and erratic decisions to buy, sell, or hold that can really hurt someone's portfolio. We’re to help you avoid market noise with well-executed financial planning that won’t fall for the jump scares of the market.
How to Spot Market Noise
In layman’s terms, the difference between noise and information is simple: information provides evidence to back up a claim, while noise doesn’t. Noise is simply there to cause confusion and uncertainty about something on the market.
For example, if a negative news story about a company comes out in the morning, a noise trader may oversell stock at a lower price. An informed trader, on the other hand, will remain calm and suggest that stock price shouldn’t dip as low as the noise traders are selling it for. An informed investor who picks up on the noise trader risk can feasibly buy the stock at that lower price with the confidence that it will rise again.
Positive news about a company can also artificially inflate market value if noise traders decide to buy stocks at an abnormal rate. This overreaction to good and bad news is what causes market noise in a nutshell. The inability to remain calm and collected while taking things at face value causes noise trader risk, but there's a way to prepare for it.
Planning Ahead of Market Noise
To say that you can completely avoid market noise may be an overstatement depending on who you ask. That said, experienced traders who have a well-developed system in place are always going to be more strategic in their financial planning.
The best way to do that is through careful research. Then, based on that research, create standards and processes that you don't deviate from at random. Know your risk limits and trade based on real information as opposed to noise. While it’s impossible to completely eliminate noise as an influencer, this can minimize it and give you a personal code of conduct to follow.
Remember, don’t always take news or word of mouth as it is. Do your own research, and you can build the confidence to avoid impulse trading. Once you’ve established a system, it will be much easier for you to function with a better understanding of the difference between information and noise.
Our trusted team of advisors can help you make informed financial planning decisions that are based on carefully researched information, not market noise. Contact us today!