This article appeared in the April 2014 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Gary Stone, Share Wealth Systems
In these days of the 24-hour news cycle, and the ease of access to a huge and varied array of news, data sources, opinions and instant updates, investors must deal with the continuous bombardment of "market noise" when arriving at investing decisions.
This proliferation of "news" and "noise" stalks us wherever we are or whatever we are doing. Many even go looking for it during every spare few seconds they have.
It comes from television, newspapers, brokers, blogs, newsletters, magazines, Twitter feeds, Facebook pages, internet chat forums, LinkedIn, families and friends, and a whole range of other sources.
Qualified journalists, expert commentators and anyone with an opinion can easily publish their views. But what is pertinent to us and what is just noise?
Take an investor who uses fundamental analysis (the study of company and industry information) to make investment decisions. This investor is meticulous in their analysis of company data, including balance sheets, profit-and-loss statements and specific accounting ratios to arrive at "what and when" decisions to buy shares in particular companies.
Having thoroughly analysed a given company and arrived at a decision to purchase shares in a particular company today, the investor switches on TV and hears that, according to Mr Expert's opinion, the impact of a seemingly insignificant event somewhere else on the planet will have a negative impact on the company's share price.
Hearing this, the investor has a knee-jerk subjective reaction and overrides all the hard work carried out according to the fundamental criteria that were researched, and decides not to purchase.
This is an example of being seduced by market noise.
Why was the information received via TV by this investor classified as noise? Simply because it was not one of the defined criteria in the investment decision-making process.
In essence, any external information that is not part of a predefined investing process can be classified as noise.
Define your investing process in order to define noise
Investors fall into two distinct categories. Those who:
- Have a clearly defined process that describes the criteria for when and what to buy, how much to risk in any single market position, and when to sell
- Do not have a process.
Those who have a clearly defined process can objectively determine what information is relevant to execute their investment process and where they are going to source it - all other information, regardless of its perceived importance, is market noise and therefore irrelevant.
If an investor deems that information external to an existing investment process may be relevant, then that information can be researched over a large enough sample of scenarios to objectively determine whether to include it or not in future investment decisions. If not, let it go.
The saying, "If you stand for nothing, you'll fall for anything", applies to investing more than anything else you will do in life.
Dangers and traps of not defining noise
Most people do not have a defined investing process, which leads to reacting, or over-reacting, to market noise and opens the investor to being influenced by the loudest noise, or noise that is filtered by the investor's subjective perceptions, and biases of what may be positive or negative information for their investing approach.
Such investors tend to magnify perceived bad news and make subjective investment decisions on the fly, based on information that has little contextual base to what they are trying to achieve.
As a consequence, these investors, by default rather than good planning, get sucked along among the noisy crowd trying to constantly work out what is happening in the markets on a day-to-day basis.
They knee-jerk react to heat-of-the-moment influences, which tend to be highly emotional decisions, fuelled mainly by fear, uncertainty and doubt, and are manifested through lack of trust in the markets, the market noise and one's self.
Whatever it may be, the effect of noise on the ill-prepared investor can be emotionally and financially tumultuous, because they "stand for nothing", which allows noise to sway their disorganised decisions.
Filtering the news from the noise
With thousands of variables at play in the financial markets on an ongoing basis, it is absolutely impossible to keep up with all the events and all the information flow all the time.
Investors need to simply accept this as a fact and focus on solving how to deal with the givens of the environment. They must learn to focus on what is important and pertinent in the context of what their objectives are, and design a structured investment process accordingly.
Well-thought-out decisions can be made according to a set of rules or clearly defined parameters compiled through scenario research. This provides a big-picture perspective that is aligned to a strategy that has withstood rigorous research.
Defining a personal investment process will automatically determine which information is noise and which is not, for your particular investment needs.
A technical or fundamental approach, or both?
It has been a well-accepted fact for years that the price of any stock is simply a reflection of all the buying and selling decisions being made by all types of investors, operating in different timeframes, as the market itself constantly digests all the information available at any point in time.
Therefore, price action, in a chosen timeframe, can be used to filter the non-pertinent market noise from a clearly defined process that provides investors with objective rules with which to engage the market in a consistent manner. This is called technical analysis (the study of chart patterns).
Another way is to analyse company balance sheets, profit-and-loss statements, and a host of other measures of company financial performance to arrive at buy and sell decisions. This is called fundamental analysis.
A final thought
Detailed and unambiguous processes can be established to allow investors to arrive at objective buy and sell decisions. Having a clearly defined investment process and plan liberates investors from the noise to engage the market on their own terms.
About the author
Gary Stone has more than two decades of experience and is founder of Share Wealth Systems, a leading provider of sharemarket trading strategies. Download his report Survive and Thrive Investing, to discover what results are possible from the market and how to avoid hidden pitfalls.
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