Noise Trader
Candlefocus EditorThe noise trader’s behavior has implications for the markets and participants in them because by increasing volatility, prices become distorted and can stray far from their fundamental and technical value. In instances when noise traders become the dominant player, prices tend to assume a random character, as herding can cause prices to become disconnected from their underlying fundamentals.
A number of factors help indicate the presence of noise traders in a market and explain their trading behavior. First, their actions often appear coincidental and unpredictable, making them difficult to foresee. Secondly, they move into markets in bursts and are quick to overreact to news and market movements. Noise traders often make decisions based on past performance and have limited capital, so they cannot stay in the market for long.
Finally, noise traders can cause an inefficient market because they buy and sell stocks without considering current economic conditions, awarding stocks an artificial and unsustainable evaluation. Such events can cause equal and opposite actions, resulting in prices climbing too high or collapsing, with shifts in volumes and prices occurring without a construct.
The unpredictability and incoherence inherent in the action of noise traders are difficult to ignore, but investors should be aware of the implications of noise traders, who can disrupt market stability and cause confusion. Acknowledging the potential impact of these types of traders when analyzing a stock’s potential allows an investor to create a more rational and reliable investment strategy.