Markets don't always behave as expected, and prices don't always move in the expected direction. While the fluctuations that come into play in the financial markets are common, most occur out of logic. Market noise often causes prices to behave erratically without any cause. Continue reading to learn what is market noise and to develop strategies for more successful trading outcomes.
What is Market Noise?
It refers to the random fluctuation of the price with no logic or volume. Given that the fluctuations are not a result of any fundamental change, they could amount to market manipulation. Errant triggering of stop-loss orders could trigger erratic price fluctuations.
The wild fluctuations that come into play due to market noises distort an asset's price. It can affect any asset class, from stock to cryptocurrencies, forex, and indices. Moreover, the erratic price movement makes it difficult to analyze an asset and find the ideal entry and exit levels while trading.
The price chart above shows the DocuSign stock price chart. The price was in a downtrend. However, there are periods when the price gapped lower, making it difficult to know when to enter or exit a trade.
Market Noise Importance
While market noise causes traders to make irrational decisions, it also has its good side. It often leads to a balanced market whereby people are buying and selling. Finding someone to sell to would be easier if there were market noise.
In a market where there is no noise, any trader who discovers an asset is underpriced cannot take advantage of the discovery. Whenever such a trader tries to buy the asset, there will be no traders willing to sell their shares to them as both expect the price increase.
Therefore, market noise ensures a person is always on the other side of the trade to complete a transaction.
How to Deal with Market Noise
The ultimate goal in trading is to buy low and sell high. To achieve this, one must know whether the asset is fairly priced at the prevailing price. Therefore, it is important to filter the market noise.
The following are some of the proven ways of filtering market noise.
Focus on higher time frames
Lower time frames show significant price movement while analyzing or looking at price charts. It becomes much more difficult to ascertain the direction price is moving. The noise in the lower price charts is usually high resulting in wild swings with prices moving in either direction.
Higher time frames, on the other hand, hide the noise as one candlestick considers activities that took place. With higher time frames, it is much easier to determine the direction price moves as all the small price fluctuations are absorbed into one candlestick. Additionally, small fluctuations cannot alter a long-term trend.
Use multiple time frames and charts for analysis.
If you are a day trader or swing trader who carries analysis and trades based on short time frames, looking at multiple time frames or analysis would help detect any noise in the market. For instance, if you are looking at the 1-minute chart, there might be wild swings or a gap that makes it difficult to know the trend in which the price is moving.
On the other hand, looking at the 15-minute or one-hour chart could provide more clarity as all the market noise would be absorbed with the fluctuations in the short time frame not appearing.
Focus on long-term trends.
Trend trading is one of the best ways of averting the risk of falling prey to market noise risks. The normal minor corrections don't affect the underlying long-term trends, as seen in daily or weekly charts.
Minor corrections inside a long-term trend are often market noise that subsides after some time. Focusing on long-term trends makes reducing exposure to market noise that triggers short-lived price swings easier.
In addition to analyzing different time frames, using different charts could help curate the market noise debacle. For example, market noise is primarily visible in candlestick charts, whereby the candles are spread far and wide with gaps visible. On the other hand, the line chart offers a continuous line without any gaps.
Use technical indicators
There are technical indicators that help traders identify small and significant price swings in the market. Zigzag is one such indicator that marks swings in the market. Smaller fluctuations triggered by market noise are usually not highlighted in the chart; therefore, they won't affect a trading decision.
On the other hand, significant fluctuations, probably due to fundamental changes in the market, are highlighted, which traders pay close attention to.
In the price chart above, the indicator highlights significant price fluctuations that provide a whole new idea of the direction that prices were moving and the major fluctuations, not smaller ones, due to market noise.
Trend Following Strategy to Trade in Noisy Market
Market noise mostly occurs during significant news development or events that cause traders to react erratically. Given that the wild swings that come into play make it difficult to know the direction price is moving, relying on trend-following strategies can help avert the risk of falling into the noisy environment trap.
The trend-following strategy involves using a moving average to identify the average price of a given asset and the direction in which the price is likely to move. Therefore, regardless of the swings that come into play, the moving average will provide valuable insight into the underlying trend and market momentum.
For instance, whenever the price is above the 50-day moving average, it implies the underlying asset is in an uptrend confirming bullish momentum. Likewise, whenever the price crosses the moving average and moves lower, it means a change in trend to a downtrend, implying a buildup in selling pressure.
Therefore, traders can look to open buy positions if the price is above the 50MA. Any pullback close to the moving average, followed by a bounce-back, signals that bulls are still in control and that price will likely continue moving up.
Similarly, traders can look to open a sell position whenever the price is below the 50MA. Any bounce back close to the MA followed by an immediate sell-off affirms the bearish momentum, indicating short sellers are in control and likely to continue pushing prices lower.
Bottom Line
Market Noise is synonymous with erratic behavior in lower time frames, making it difficult to ascertain the direction price is moving. While it cannot affect a trading account, it can make analysis less effective. The best way to avoid the pitfalls of market noise is to focus on higher time frames and different charts when carrying out an analysis or studying the market.
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