Once upon a time I used to believe that trading was an information management profession but I have slowly begun to change my opinion. Trading has become a noise management profession – noise is everywhere in trading and its influence is becoming more pronounced as time marches on. When I first became interested in markets the only way you could find out what happened overnight was to either get up early and watch Michael Pascoe’s business show or if you wanted to sleep in trust that your VCR had managed to capture the vital few seconds where overnight markets were being discussed. For those of you who don’t know what a VCR is, it was an electronic device approximately the size of a shipping container which would record tv programs onto a blank cassette. It could be a somewhat hit or miss affair.
When I first entered broking overseas orders were taken via a telex – the notion of talking to someone overseas was out of the question. We were barely out of the days when you had to book an overseas phone call. Nowadays this is all behind us as anyone can call up any market in the world on their smartphone whilst waiting for the kettle to boil. This easy access to information is problematic, not only because of the human brains inability to deal cohesively with more than a few inputs but also from the perspective of simple distraction.
Consider this noise in light of trying to make a coherent decision. Lets imagine we are trying to decide whether to add CBA to our portfolio, as such we generate a bit of technical analysis. From which we define the following –
1. CBA endured a period of lengthy consolidation between 2010 and 2013.
2. There seem to be three dominants trends within CBA.
3. Share price is well away from two of these trend lines.
4. Price is currently hugging the third and most recent of these trend lines.
5. Price has failed to move beyond its previous 52 week highs for approximately eight weeks.
6. Price appears to have stalled at the $82 mark.
From this we could reasonably define that there is no immediate signal to enter CBA and that the next signal will be the creation of a new 52 high beyond $82. Our analysis could actually be reduced to enter long on a new 52 week high beyond resistance – this actually eliminates most of the earlier analysis and gives us a blunt but very clean form of analysis. By reducing the number of input variables but maintaining the fidelity of information we have reduced the amount of noise we have to tolerate within the system. This is what I would consider the holy grail of trading systems.
However, there is an assumption within technical trading that the more information you have on a chart the more information it gives you. I would offer that the reverse is actually true – the more you obscure price the less information price actually gives you. My belief is that the price you see when you go to trade any instrument is the end result of what is effectively a voting machine – the market votes on which narrative it considers to be correct at the time. Unfortunately, it is impossible to know in advance which narrative the market will decide is the best as such all trading is reactive in nature. It is possible to only set landmarks or sign posts that trigger you into action. Traders who either lack the confidence to accept this or who lack the emotional control to deal with being reactive begin to get sucked into the noise of trading. It would be quite possible for traders to desperately search for some form of analysis that they think will tell them the future, so they start to plaster the chart with noise such as Fibonacci retracements or Gann fans and in this process price is lost. The attempt to generate emotional security has generated noise.
This problem extends itself when you begin to move into the idiocy that is the internet, type in CBA share analysis into Google and you will get about 1.4 million hits. Each of these hits adds to the problem of noise. So our simple analysis of go long beyond resistance has degenerated into mess of noise and distraction. In part though I would suggest that the infiltration of noise into trading is part of a wider problem face by traders. Noise is a form of distraction. It is well known that distraction is a problem within any working environment, workers will on average only get 11 minutes of actual working time in between interruption. However, it takes 23 minutes to return to the original task. You might not think that this sort of problem would exist for traders since they live in their own world but instead of thinking of distraction or interruption as something someone does to you think of how many times you interrupt yourself. Consider our earlier example of CBA – how many times during your analysis time do you drift off to check news sites, see what is being said on a given forum or listening to a talking head on one of the business channels? Noise for humans seems to be both seductive and disruptive.
All of this naturally raises the question of how to reduce noise. In part the answer comes down to emotional maturity and the ability maintain concentrated focus on a given task or event. I would have to agree with this piece on the role of clutter in maintaining focus, but I would extend the notion of clutter to beyond the physical. Clutter is a form of noise and noise can be emotional as well as physical and it is here that I think the problem of trading noise becomes reinforcing. The more emotional clutter you bring to trading the more noise you will seek out to overcome your clutter and the more cluttered you and your trading becomes. This pattern simply feedsback upon itself until it is impossible to make any form of decision.