This is a separate page of the N-O section of the Glossary
Behavioral finance FAQ / Glossary (Noise)
Dates of related message(s) in the Behavioral-Finance group (*):
Year/month, d: developed/ discussed, i: incidental
02/2i,4i,10i - 03/1i - 04/1i - 07/7i + see boredom, overtrading, trend following, hyperactivity, information, technical analysis, cognitive, signal, cascade
Dear, I heard noise downstairs in the shop. Is it the cat or do we take the gun?
Definition #1 (system noise)
Noise is a minor, slightly noticeable but common type of events, due to the ordinary vibration of a system, which is poor in real information about the system and its environment. The "Sound of silence" as the song says.
(see that word).
Not only a noise does not bring anything relevant, but it might drown some crucial signals and make them inaudible!
Noise is like ants at the picnic!
Noisy markets?
Market noises often take the form of small price moves without real changes in economic situations and prospects
Noise trading is a
compulsive / hyperactive buying and selling activity (see overtrading) in financial markets, done in the absence of meaningful new information, except erratic price moves, trifle or misunderstood news or unverifiable rumors.
Those frantic actions (see overtrading, boredom):
Any noise makes them jump.
A noise trader is somebody who practices noise trading, exclusively, continuously, and indiscriminately.A market insomniac?
Noise traders usually follow the
trends. They
When seeing a price rise or fall, they ride that horse.
They might even give less importance to information that are more fundamental but which potential effects take more time and efforts to analyze.
Noise traders create
market anomalies that bring risks for investors who base their valuations on fundamental analysis.
The risk is that, although market prices differ from their "fundamental" valuations, the difference can get amplified instead of corrected.
Therefore they follow what those other traders do even when they are erring (see cascade, herding, mimicry....).
They put themselves also in a risky position, as those other traders, who are hyperactive too, can change erratically
their mood and behavior.
Noises from the street and noises from home
Nothing better to listen?
Those rather meaningless market information, but that market traders are addictive to interpret as decisive, usually take the form of:
anecdotic info, wrongly considered as changing the economic fundamentals),
of financial medias, bloggers, tip givers, tip sellers, (oops, let us call those people "financial experts": see "obedience to experts").
They always try to explain what is going around with a "good story" (see story).
They also spread gossips and rumors, like did Madame de Sévigné commenting the little events of the Royal court.
minor vibrations / zigzags in market prices and volumes.
They are random blips due mostly to... noise traders who act erratically, upon whims more than rationally or upon relevant information.
Noise traders interpret those noises, even if other noise traders were their sources:
Sometimes as mispricing that offer arbitrage opportunities, in the hope that the price will swing back (why not, although this is an hazardous bet)
They take it as an opportunity to make money by following it.
Here comes the "representativeness heuristic" (see that phrase), one of the dangers of seeing technical analysis configurations everywhere, as signs in the sky.
Routine and speed.
First, let us say that noise traders can make some money in rather eventless periods when a trend is rather settled. Then noise overcomes consistent information as a market pricing factor.
But it is a stressful activity. Such a jungle rover needs the speed of a tiger to prey on his protein sources. Also he can be easily wiped out of the financial ecosystem when the market climate changes.
Usually, noise traders base their decisions on:
(= those that alter economic fundamentals, not directly the financial sphere),
know the importance of feeding the market with frequent shots of information, one of the drugs it is addicted to.
No policy maker, no company, no business guru, nor rumor-monger, has the inventive capacity to release a breaking news, considered important, every 15 minutes like a cuckoo clock.
= those concerning the market itself, such as its day to day or intraday moves that reflects what other traders do.
Among those sources, technical analysis is a purely endogenous tool.
Why do some consider noises as information?
Noise traders by definition do not
"filter" real information / signal from "noises".
Also their actions create their own "noises": noise trading brings more noise trading, as seen in the "cascade" article.
Of course, we have to admit that noise filtering / screening is far from easy, as:
"newsflow" and the related
human stress, are at play,
All this make it difficult for people to focus their attention on what is the most important, or to sort it rationally and efficiently.
What do noises bring to the market? Din or good music?
Those noise operators spend time doing
intraday, or at least short term, buying and selling.
This "overtrading" (see that word) has several effects:
liquidity to market by inflating the volume of transactions.
In practice, it creates a quasi continuous presence of counterparts for buy and sell orders,
costs for traders.
This plays against the profitability of their trades and also, often, against their survival as market players
.
Stock markets, and other financial markets, mostly when they are "bubblish", have numerous noise traders that take the trend itself as a signal.
Here noise trading and trend following go hand in hand.
Do we have here noise-driven CAPM instead of information-driven CAPM?
We have here an anomaly compared to the efficient market hypothesis (see that phrase). Unless we accept, in its "weak form", that not only fundamental data and events, but also endogenous market information (noise) and investor perceptions play a part in market pricing.
Good bye, noise, hello thunder!
A
change of sentiment by some of those traders, who
realize suddenly how market values went far from fundamental values, is sometimes the random "butterfly wing flip" that shifts the entire market trend from bullish or bearish to the opposite direction.
This applies mostly to crashes
, that have all the reasons to happen, but that strike often at moments when no crucial additional breaking new on fundamental issues occurs.
(*) To find those messages: reach that Behavioral-Finance group and, once you are there, 1) click "messages", 2) enter your query in "search archives".
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