Trade The Journey

Trade The Journey

Noise Traders vs Information Traders Part 1

Most have never heard of the term of Noise Trading and neither did I before reading a passage in “Advances in Behavioral Finance“. Its one of the books that you look at in the library and wonder who has time to read all of this. When you open the book the terminology alone will throw you for a loop. Noise trading vs information trading is one of the major themes so far in the book.

Noise Trading is information that hasn’t arrived yet. Uncertainty about future demand and supply conditions within and across sectors. Noise trading can be seen all around you and it comes in the form of advice from a neighbor, coworker, family member, and the news. It’s information that is most widely known but presented as if it is one of the best-kept secrets. “You better hurry and invest in this stock” and for me, it happened to be cryptocurrency which I am still invested in.

The noise trader makes trades based on what Howard Marks would define as first level thinking. Second level thinking involves taking the next step in thinking about an investment. Although this price drop might signal a decline in the company, what is really happening within the company or the stock being traded? Howard Marks first question when evaluating a companies stock is, “Who doesn’t know that?”.

In part 2, I’ll look into how the efficient market theory affects your trading style and how information traders view it versus noise traders.

Noise traders believe that the price of the future asset can be predicted and they know almost certainly that the price will go up. In my short experience of trading options, it almost never happens that way and what you think will go up inevitably goes right back down.

The information trader, on the other hand, is well positioned and is easily able to adapt to the changing price patterns of the asset. “Sophisticated (Information) traders buy when noise trader depress prices and sell when noise traders push prices up.” Because the noise trader trades on news and is uncertain on what the price will be after entering into the asset, the asset becomes volatile As you can see there are  more noise traders than information traders.

So how can you become an information trader?  I would assume that second level thinking might be of help to us in understanding how an information trader operates. The information trader, I  imagine would understand the markets intuitively, is a constant observer of consumer sentiment and have industry knowledge. How many times have you seen or heard of someone investing in an industry they have no knowledge of? And completely disregarding the industry they work in or have direct knowledge of.

For example, I know someone who worked in the science/pharmaceutical field but was invested in oil stocks. How much easier would it have been for them to be invested in the science industry? They probably would have access to industry developments before any outsiders. One question that I always ask myself when I look at a company is how well do I know the industry?

 

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