Market Noise and Signal

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  • on November 3rd, 2012

“Market noise is very similar to market volatility, and can be thought of as chaotic price movements that are not congruent with the market’s underlying trend” Nick Libertini, 361 Capital

I shared this paper earlier in the week, but felt it deserved more attention. The opportunities to learn and share online continue to astound me; I became familiar with the fine work of 361 Capital thanks to Josh Brown, and the discerning eye of Meb Faber brought this earlier paper of theirs to my attention. I felt compelled to share it again, as it holds the combination of depth and readability that is rare in such papers…here are a takeaways:

1) Institutional agendas are not always aligned with maximizing returns, and often act as a huge source of noise 

2) Failing to identify a “noisy” market environment not only puts as at risk of whipsaw, but might frustrate us away from trends at the very time they are about to take over from the noise

3) The complexity of interpreting endless market data ensures that noise will continue to be the predominant factor in short-term market movements 

Most traders know all of the above, though we sometimes forget that it’s the sloppiness and slowness of the big money that gives us our best trading opportunities. The key is what to do about it, and the author has graciously shared a) a basic description of the noise issue, b) one way to measure the amount of noise, and c) one basic prescription for including this in our approach.

Whatever our style and timeframe, I think the most important thing is to record the same information at the same time, day after day…it’s amazing how quickly those habits develop into a reliable intuition in noting a shifting environment. The earlier we spot the shift, the more we are able to make our trades amidst market doubt, rather than when obvious to all.

Over time, I’ve moved away from trying to squeeze the effects of noise vs. signal into the perfect trade, and towards isolating trend trading and counter-trend trading into separate strategies. Either way, we all face this conflict when planning our exit. How much room do we allow for retracements? When can a short-term winner morph into an intermediate-term hold? How do we balance the noise of the lower timeframe against the signal of the higher, or vice versa?

To deny that noise is a threat to our objective analysis of trends strikes me as either naive or arrogant, or both. Conversely, efforts to be the world’s best “fader” are likely the same, but at least those who respect the force of trends stand a chance. This paper is one of the best I’ve seen at presenting balanced evidence and letting the reader figure out what works for them, and I can’t see how there’s not something in there for each of us to consider.

Read: “Counter-Trend Trading” by Nick Libertini, 361 Capital


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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