Noise (economic) - Finance

Finance

People trade speculatively because they disagree about the future; this company will grow a great deal over the next three years, this commodity will become cheaper starting next month, and so on. These disagreements stem from the fact that everyone interprets information or data differently and subjectively. Because some of the complex nature of the world's markets, not all market data is "information." Much of the price fluctuations we see on a day-to-day basis are due to random change rather than meaningful trends. Thus, the problem of discerning the real information from the noise presents itself. This problem is what drives trading in a market; if everyone knew all things, then no trades would occur because there is general agreement on how the economy will unfold. In real life, however, trades occur as a kind of bet on what is noise and what is information; generally the more skillful, and technologically advanced, "gambler" wins.

This trade takes place between what Black calls information traders and noise traders, where the former operates based on accurate information and the latter trades based on noise. Unfortunately, there is no way of precisely parsing the noise and information from a data stream or signal, so the so-called noise traders tend to think that they, in fact, trade on information that others in the market simply reject as noise. Thus, methods of parsing noise and information from a signal are becoming increasingly important in the market-place, especially as strategies used by high-tech alternative investment firms, such as some hedge funds.