Our resident head doctors take a
look at traders In 1985 Fischer Black published a paper entitled “Noise”. In this he argued that much of the irrationality in financial markets could be explained by people trading without information: essentially using various spurious signals to decide when to buy or sell. In fact there’s an argument that without such people markets couldn’t work at all. The downside of this is that it’s difficult to separate the noise from the information.
Black predicted that there would be people who spend their lives trading on noise – so-called “noise traders”; people that Paul Krugman calls "idiots". Unfortunately these idiots generate so much noise that it’s very hard to determine the real information, which would suggest that if we're not careful, at root, we’re all idiots.
Ironically the activities of these noisy traders acting within the "free" market suggests that we are all Keynesians now
The research shows the truth of Keynes’ old maxim that markets can stay irrational longer than we can stay solvent. Rather than incorporating all available public information they may be signalling nothing but noise traders betting against themselves and (hopefully) slightly smarter investors betting on the behavior of the traders. This is not a game most of us we should want to play, because betting on other peoples' mental states is a risky business that requires constant attention.
Anyone not steeped in the moment by moment discovery of share prices needs to seek out real information rather than noise, to focus on value rather than price. However, to succeed you need to ensure you can outwait the irrationality, which may require patience and deep, deep pockets. Anything else is just behaving like an idiot.
