Noise

DEFINITION of 'Noise'

In a broad analytical context, noise refers to information or activity that confuses or misrepresents genuine underlying trends.  

BREAKING DOWN 'Noise'

Used in the context of equities, noise signifies stock market activity caused by program trading, dividend payments or other phenomena that is not reflective of overall market sentiment. In this context, it is also known as "market noise." The concept of noise was formally introduced in a landmark 1986 paper by economist Fischer Black, where he stated that "noise" ought to be distinguished from "information" and that a disproportionate amount of trading occurred on the basis of noise rather than evidence.

All trading is somewhat speculative, but noise traders are considered to be particularly reactionary, relying on trending news, apparent surges or declines in prices or word of mouth rather than the fundamental analysis engaged in by more experienced traders. In general, the shorter the time frame, the more difficult it is to separate the meaningful market movements from the noise. The price of a security will vary widely throughout a given day, but almost none of this movement represents a fundamental change in the perceived value of the security. Some noise traders attempt to take advantage of market noise by entering buy and sell transactions without the use of fundamental data.  

If most market fluctuation is noise, however, then most traders are noise traders. Only hindsight provides assurance of the credibility of information, and when buying and selling stocks at a rapid pace, it is difficult to distinguish "information" from "noise." However, there are some fairly predictable market fluctuations that are known to be unreliable as indicators. It is almost always a bad idea to make trades based on information you've received only that day: the price of a security will fluctuate wildly within a day, and much of this price movement is deliberately manipulated by professional traders to manufacture market advantages.

Furthermore, much of this trading is actually program trading, which means that a large investment institution has programmed computers to make trades when prices reach a certain level. It's also advisable to be on the lookout for artificial bubbles, which are often created when many noise traders congregate their purchases around a single company or industry, and for corrections, reverse movements of more than 10% of the value of a security which occur as adjustments to a significant overvaluation of the security.

Most effective traders have personal standards or processes which they use to make trading decisions: they know how much they'll risk on a trade and they know, with some precision, what will constitute a wise move for their current position. Generally, people who do not have a process for arriving at a decision are more susceptible to noise trading. Making decisions based on personal standards doesn't remove susceptibility to misinformation, but traders who know what they're looking for are far less likely to be swayed by noise than traders who rely on news or other fluctuations.

RELATED TERMS
  1. Noise Trader Risk

    A form of market risk associated with the investment decisions ...
  2. Accounting Noise

    The distortion that is caused in a company's financial statements ...
  3. Noise Trader

    The term used to describe an investor who makes decisions regarding ...
  4. Applied Economics

    The application of economic theories and principles to real world ...
  5. Member Short-Sales Ratio

    A ratio comparing the number of short sales transacted on behalf ...
  6. Trading Session

    A period of time consisting of one day of business in a financial ...
Related Articles
  1. Markets

    Avoid The Perfection Trap In Trading (CELG)

    Avoid the perfection trap and make peace with the market’s high levels of systematic noise.
  2. Markets

    Using Technology To Tune Out Market Noise

    Today’s technology-centric culture allows us to have access to information anytime. As investors, we can be informed of market moving news as it happens.
  3. Trading

    The Right Trading Position For A Good Night's Rest

    The last hour of the trading day is the perfect time to ask these questions about your overnight exposure.
  4. Markets

    Explaining the Coase Theorem

    The Coase theorem states when there are competitive markets and no transaction costs, bargaining will lead to a mutually beneficial outcome.
  5. Trading

    Tic-Tac-Toeing Your Way To Better Returns

    Point-and-figure charts eliminate the noise surrounding a stock to help you determine where it's headed.
  6. Trading

    How To Outperform The Market

    Active trading is an investing style that aims to beat the market. Find out how it works, and whether it will work for you.
  7. Trading

    Informed Traders: Fundamental Traders, Technical Traders

    When day trading or long-term trading, fundamental and technical forms of analysis are two of the most common methods that may be employed. These forms work from the same data, but the way they ...
  8. Trading

    An Introduction To Day Trading

    This article will take an objective look at day trading, who does it and how it is done.
  9. Financial Advisor

    A Day In The Life Of A Day Trader

    Day trading has many advantages and, while we often hear about these perks, it's important to realize that day trading is hard work.
  10. Trading

    Moving Averages: Introduction

    By Casey Murphy, Senior Analyst ChartAdvisor.com Technical analysis has been around for decades and through the years, traders have seen the invention of hundreds of indicators. While some technical ...
RELATED FAQS
  1. Do noise traders have any long-term effect on stock prices?

    There are two theories that are used to describe how securities are priced in the stock market: the efficient market hypothesis ... Read Answer >>
  2. Why would my stock's value decline despite good news being released?

    More often than not, when a firm releases an earnings report the market will react to this news by adjusting the firm's stock ... Read Answer >>
  3. Why is the Moving Average (MA) important for traders and analysts?

    See why the statistical concept of moving averages plays a central role for traders and chartists who rely on technical analysis ... Read Answer >>
  4. What are some common hand signals on the trading floor?

    "Hand signal" is the sign language used by traders to transmit basic information on the trading floor. The use of hand signals ... Read Answer >>
  5. How do traders identify confirmation of prices on a chart?

    Learn about some of the crucial tools that traders can use to confirm their price movements on a chart before entering or ... Read Answer >>
  6. What types of data are necessary to make a technical analysis?

    Understand what technical analysis is, the basic theory behind employing it and what data inputs are needed to conduct it. Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center