Dangers of being seduced by ‘market noise’

In these days of the 24-hour news cycle, and the ease of access to a huge and varied array of news, data sources, opinions and instant updates, how do investors deal with the continuous bombardment of ‘market noise’ when arriving at their investing decisions?

Over supply of information

A constant stream of news, views and opinions are bombarding unsuspecting investors 24 hours a day, 7 days a week, regardless of their investing style.

With the proliferation of the internet and its inter-connected web of social interaction and news related media, the ‘news’ and ‘noise’ is everywhere as it stalks us wherever we may be or whatever we may be doing! Most even go looking for it in every spare few seconds they may have!

The ‘noise’ comes from the television, newspapers, brokers, blogs, newsletters, magazines – online and print, Twitter feeds, Facebook pages, Internet chat forums, LinkedIn, news feeds, tips from families and friends and a whole range of other sources.

Qualified journalists, expert commentators and anyone with an opinion that can easily publish their view is a part of the constant flow of information. But which is pertinent to us and which is ‘noise’?

An example

Take an investor who uses fundamental analysis to make their investment decisions. This investor is meticulous in her analysis of company data including balance sheets, profit and loss statements and specific accounting ratios to arrive at her ‘what’ and ‘when’ decisions to buy shares in particular companies.

Having thoroughly analyzed a given company and arrived at a decision to purchase shares in a particular company today, the investor switches on CNBC TV at breakfast time only to hear that, according to Mr Expert’s opinion, the impact of a seemingly insignificant event somewhere else on the planet will have a negative impact on this company’s share price.

Hearing this, the investor has a knee-jerk shoot-from-the-hip subjective reaction to this news and over-rides all the hard work that was carried out according to the fundamental criteria that were researched, and decides not to go ahead with the decision to purchase.

This is an example of being seduced by ‘market noise’.

What is ‘market noise’?

Why was the information received via CNBC TV by this investor classified as “noise’? Simply because it was not one of the defined criteria in her investment decision making process.

In essence, any external information that is not part of a predefined investing process can be classified as ‘market noise’.

Define your investing process in order to define ‘noise’

Investors fall into two distinct categories. Those that:

• Have a clearly defined process that describes the criteria for when and what to buy, how much to risk in any single market position, and when to sell.
• Don’t have a process.

Those that have a clearly defined process can objectively determine what information is relevant to execute their investment process and where they’re going to source it – all other information regardless of its perceived importance is ‘market noise’ and hence is irrelevant.

If an investor deems that information external to an existing investment process may be relevant then that information can be researched over a large enough sample of scenarios to objectively determine whether to include it or not in future investment decisions. If not, then let it go.

The saying, “If you stand for nothing, you’ll fall for anything”, applies to investing more than anything else one will do in life.

Dangers and traps of not defining ‘noise’

Most don’t have a defined investing process which leads to reacting, or over-reacting, to ‘market noise’ and opens the investor to being influenced by the ‘loudest noise’, or ‘noise’ that is filtered by the investor’s subjective perceptions and biases of what may be positive or negative information for their investing approach.

Such investors tend to magnify perceived bad news and make subjective investment decisions on the fly based on information that has little contextual base to what they are trying to achieve.

As a consequence, these investors, by default rather than good planning, get sucked along amongst the noisy crowd trying to constantly work out what is happening in the markets on a day to day basis.

They knee-jerk react to short term heat of the moment influences which tend to be highly emotional decisions fueled mainly by fear, uncertainty and doubt and that are manifested through lack of trust in the markets, the ‘market noise’ and self!

Whatever it may be, the effect of ‘noise’ on the ill-prepared investor can be emotionally and financially tumultuous because they ‘stand for nothing’ which allows ‘noise’ to sway their disorganized decisions.

Filtering the news from the ‘noise’

With thousands of variables at play in the financial markets on an ongoing basis, it is absolutely impossible to keep up with all the events and all the information flow all the time.

Investors need to simply accept this as a fact and focus on solving how to deal with the givens of the environment. We must learn to focus on what is important and pertinent to us in the context of what our objectives are and design a structured investment process accordingly.

Well thought out decisions can be made according to a set of rules or clearly defined parameters compiled through scenario research. This provides big picture perspective that is aligned to a strategy that has withstood rigorous research.

Defining a personal investment process will automatically determine which information is ‘noise’ and which is not, for your particular investment needs.

A technical or fundamental approach or both

It has been a well-accepted fact for years now that the price of any stock is simply a reflection of all the buying and selling decisions being made by all types of investors operating in different time-frames, as the market itself constantly digests all the information available at any point in time.

Therefore, price action, in a chosen time-frame, can be used to filter the non-pertinent ‘market noise’ from a clearly defined process that provides investors with objective rules with which to engage the market in a consistent manner. This is called technical analysis.

Another way is to analyze company balance sheets, profit and loss statements, and a host of other measures of company financial performance to arrive at buy and sell decisions. This is called fundamental analysis.

Summary

Detailed and unambiguous processes can be established to allow investors to arrive at objective buy and sell decisions. Having a clearly-defined investment process and plan liberates investors from the ‘noise’ to engage the market on their own terms.