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. Trading

    (Un)Mapping the Trend

    Much has been said about using trend analysis to gauge the market, but what do we really know about the concept "trend"?
  3. Trading

    Trading Without Noise

    False signals can drown out underlying trends. Find out how to tone them down and tune them out.
  4. Trading

    What Type Of Trader Are You?

    There are different ways stock traders attempt to profit from market movements. Which of the strategies do you use?
  5. 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.
  6. 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.
  7. 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.
  8. 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.
  9. 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 ...
  10. Trading

    An Introduction To Day Trading

    This article will take an objective look at day trading, who does it and how it is done.
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. How do experienced traders identify false signals in the market?

    Learn how traders identify false signals in the market when using indicators and strategies to better identify true market ... Read Answer >>
  3. 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 >>
  4. How should a risk-averse investor build a retirement portfolio?

    Learn about a strategy to take advantage of a higher high failure on a chart, as well as the basics of trend trading and ... Read Answer >>
  5. What are the best ways to learn and engage in investing?

    Recently decided to get into investing. Signed up with Acorns, but don’t know if that was the best move. Any help or ... Read Answer >>
  6. 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 >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center