Behavioral finance FAQ / Glossary (Noise)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

Noise trader / Noise trading

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)

Engine purr

Noise is a minor but common information / events, the ordinary
vibration of a system, a phenomenon which is poor in real new

The "Sound of silence" as the song says.

This makes it differ from a true signal (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!

Definition #1b (market noise)

Noisy markets?

Market noises often take the form of small price

moves without real changes in economic
situations and prospects

Definition #2 (noise trading)

Following the decibels?

Noise trading is a compulsive / hyperactive
buying / selling activity
(see overtrading) in financial markets
that is done in

the absence of meaningful new information, except
erratic minor price moves, trifle or misunderstood
news or unverifiable rumors

Those frantic investor moves (see overtrading, boredom):

Not only are driven by market noises, as a flow of irrelevant
that do not really change the asset's

But investors themselves are a main source of
market noise that initiates more erratic price 
moves unrelated to those fundamentals.

Definition #2b (noise trader)

Any noise makes them jump.

A noise trader is somebody who practices noise trading,
exclusively, continuously, and indiscriminately.

A market insomniac?

Noise traders usually imitate other
tradersand follow the trends.

When they see a price rise or fall, they ride that
jumpy horse.

They might even give less importance to information that
are more fundamental
but which potential effects take more
time and efforts to analyze.

Definition #2c (noise trader risk)

Market disturbance by noisy players

Noise traders create market anomalies, and 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.

The reason is that noise traders trust other traders' moves more
     than the assets' fundamentals.

Therefore they mimic those other players even when they are
erring (see cascade, herding, mimicry....).

They put themselves also in a risky position, as those other
traders, also
hyperactive, can change erratically their
mood and behavior.

What are the types of market noises?

Noises from the street and noises from home
Nothing better to listen?

Those rather meaningless market information, but which market
tradersare addictive to interpret as decisive, usually take the form of:

Some minor "exogenous" information ( anecdotic

news, wrongly seen as changing the economic fundamentals),

The "daily chatter" of financial medias, bloggers, tip 
givers / sellers (oops, let us call them "financial experts": see
    "obedience to experts").

Those people met at the village pub can always explain what is
going around with a "good story"
(see story).

They also spread gossips and rumors, like did Madame de
Sévignécommenting the little events of the French Royal court...

Or most often 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 on relevant

Noise traders interpret those noises, even if produced by
other noise traders,

Sometimes as mispricings that offer arbitrage opportunities,

hoping the price will swing back (why not, but an hazardous

More often as signals of either the birth of a short price trend

or a confirmation of a long price trend.

They see an opportunity to make money by following
the scent.

Here comes the "representativeness heuristic" (see that phrase),
when they see technical analysis configurations everywhere, as
signs in the sky.

Noise trading and trend following:
     how noise traders operate

Routine and speed.

First, let us say that noise traders can make some money in rather eventless
periodswhen a trend is rather settled.

Then noises are the only pieces of wild game on the plate and they become
the main market pricing factor.

But it is a stressful activity for those jungle rovers.

* They need the speed of a tiger (or of a quantum computer) to prey on
their protein sources.

* Also they can be easily wiped out of the financial ecosystem when the
market climate changes.

Usually, noise traders base their decisions on:

Sometimes any blip in the "newsflow" 
"information") of "exogenous" information (= those that

alter economic fundamentals, not directly the financial sphere),

Certainly, some "spin doctors" know the importance
feeding the market with frequent shots of information, one
   of the drugs it is addicted to.

But crucial information (those that really change the business
   prospects) are not that frequent.

No policy maker, company, business guru, rumor-monger,
has the inventive capability to release a breaking news,
considered important, every 15 minutes like a cuckoo

More often minor "endogenous" information

= those concerning the market itself, such as its day to day or
intraday moves that reflect
what other traders do.

Among those sources, technical analysis is a purely
endogenous  market tool.

Why are market noises not "filtered"?

Why do some consider noises as information?

Noise traders by definition do not "filter" real information / signal from

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:

Some news that might look trite are in fact weak signals (see that
   phrase) showing that major evolution are in the making and have to 
   be taken into account.

What is at play also, is a cognitive overload (see that phrase)
  and the  related human stress, when facing a massive and 

increasing "newsflow", hard to follow and to sort.

All this makes it difficult for people to focus their attention on what is the most
important, or to use it rationally and efficiently.

Noise trading, overtrading and trend following:
     what effects?

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:

Its usefulness is to add liquidity to markets by
   boosting the transaction volume.

In practice, it creates a quasi continuous presence of
for buy and sell orders,

It brings a non negligible source of fees for brokers,

On the other hand, it is also a far from negligible source ...of 
    costs for traders.

This plays against the profitability of their trades and also, often,
their survival as market players.

It tends to bring market excesses .

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?

All that makes noise traders most of the time "trend followers" (see
     trend following).

We have here an anomaly compared to the efficient market hypothesis and
its offspring, the CAPM (see the related glossary articles).

Unless we accept, in the "weak form" of that famous hypothesis, that not
only fundamental data and events, but also endogenous market information
(noise) and investor perceptions play a part in market pricing.

When reality strikes and replaces noise

Good bye, noise, hello thunder!

A change of sentiment by some of those traders, who
suddenly realize how market values went far from fundamental
values, can  be 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 are looming in unbalanced
situations when they have all reasons to happen, but which often
strike when no crucial additional breaking news on fundamental
issues occurs.

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This page last update: 12/09/15   

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