Noise: Price and volume fluctuations in the market can bias one’s understanding of market direction. Used in the context of equities, stock market activity caused by algorithmic trading, splits, bonuses, dividend payments or other phenomena is not reflective of overall market sentiment and could at best be described as “market noise”.
Signal: An event or condition that alerts investors to purchase/sell a particular share.
Financial news or events across the globe drive the markets. But how efficiently do financial markets process news of unexpected events? In general, it is very difficult to differentiate how well markets process information, because there is no theoretical way to separate fundamental news from market noise. The market participants (i.e. investors and/or traders) often spend their day surrounded by such noises.
Below we have tried to list some instances from which you can sense if it is just noise or a genuine signal:
1. Opinions or predictions: Options or predictions on different things like stock price of the company, direction of the economy, monetary policy etc, could play on investors’ emotions and push them into action more often than is ideal. For example: an investor who bought a stock with a 2 year outlook could be enticed to sell if the stock fell on some news and analyst anticipated more problems in the next quarter.
2. Sensationalism: Investors are likely to be more confused with the various signals they are receiving on a regular basis like ‘Sensex falls for 5th straight day, Nifty lowest in 2013, screams one headline. Another day, one more such headline: ‘invest in these midcap companies‘ for high returns over the next 4 quarters, reveals one article, and yet another says, ‘Disappointed India Inc seeks interest rate cut by RBI’. What does one make of this constant stream of news flow?
3. Judging future on the basis of past: Many financial new/articles (typically during the end of a quarter or year) highlights winners/losers in the stock market. However, the purpose of such articles should be just that: highlighting winners to attract their interest and prompt them into finding out what drove such performances, and whether conditions still exist that such performances could be repeated in the future. But many investors overweigh the recent information and expect such performances to continue and treat such lists as outright buy recommendations.
As investors, it is important to separate the news from the noise in the hunt for real returns. Investors need to be disciplined in their stock investing approach. It is important to take into account that day to day action tends to be a meaningless back and forth, driven as much by liquidity and technical factors as actual valuation. What matters over time is the longer term trend: Is the economy expanding? What is happening with employment, wages and retail spending? Ultimately, these economic indicators matter because they will help drive profits of the companies and will in turn increases investor return.