How Market Noise Affects Trading
Learn how market noise can provide you with key information in trading forex and stocks.
In the stock markets or even the forex markets there are a lot of factors that influence the direction of prices and the market in general other than fundamental data. This could include among other things data analysis reports and ideas that are inaccurate. Hype also counts as market noise. This noise is omnipresent not just in the markets but in the wider economy and is an indicator of inefficiencies in the market. And, as you would expect in what has been dubbed the information age, noise is rising at an exponential rate while the information that would be considered useful is not.
With regards to the equities market, noise exists where the activity of buying and selling of equities is being motivated by such things as payment of dividends which might motivate some to buy in order to cash in on the dividends while others use the increased demand to sell at a high. Noise has also been in existence when trading is being done using computer programs.
Unfortunately, for market participants, it is not always easy to distinguish between accurate information and noise. It has generally been observed that when looking at trading charts, the likelihood of being unable to separate noise from meaningful and significant market movements reduces as the time frames get shorter. Not all market participants are averse to market noise, though. Some seize the opportunities that market noise presents by engaging in speculative trading.
The primary reason traders engage in speculative trading is because they have a different opinion and outlook of the future. Thus from their own analysis, they may arrive at a different conclusion concerning say the financial performance of a listed firm, the price of a commodity or the price of a forex pair. This difference in opinion is not because they have access to different information from others but because the way human beings interpret data and information is different and subjective.
‘We see things as we are not as they are’, it has been said. Thus most of the fluctuations in prices that happen on a daily basis are not grounded in meaningful trends but rather market noise.
While traders have for a long time been categorized either as bears or bulls, they can also be classified on the basis of whether they make trades based on noise or information, so that in the end you have either a noise trader or an information trader.
The interesting thing though is that this classification is highly subjective and what you would call a noise trader may see themselves as an information trader and vice versa. What one considers noise may be information to another.
One obvious beneficiary of market noise are the speculative traders. But speculative trading is not for everyone and has it’s downsides too. Fortunately, there’s a way to rule out market noise and tell when a meaningful trend is about to start.
To tell when a major meaningful move is about to begin, the first thing you need is a trigger, which is basically anything that alerts you to the fact that a trend has started. Some of what you may use include trend lines, a chart with a time-frame of half an hour, a 1% box size, P&F chart, 1-box reversal and a percentage scaling method.
The time at which to enter a trade is largely dependent on the kind of risks you are willing to take. There are those who will enter a trade once the trigger has been ‘pulled’ so to speak. Then there are those who will only jump in after the trigger has been confirmed.
After entering a trade the question as to when to exit the trade immediately arises. This is because no trend goes in one direction infinitely without some change. The longevity of a trend can range from a few minutes to some weeks to months. Tools that come in handy in exiting a trade include P&F charts in a time-frame of half an hour and a simple moving average (SMA) with a period figure of 15. But regardless of what an individual may use to get out of a winning trade, the key thing to keep in mind is simplicity. Fancy and complicated won’t do.
It is hard or even impossible to try and predict how much profit you can get out of any one given trade. This is because it is impossible to project with a high degree of accuracy how high or low a stock or forex pair will rise or fall. If that were the case everyone would be rich. What you can be able to estimate though is how far up or down a stock is likely to go once a trend has started. This is possible by getting a stock’s volatility using the Average True Range indicator.