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Markets React to Noise in the Short Term - What Does it Mean? - ABSLMF Blog

Markets react to noise in the short term - What does it mean?

Jan 07, 2021
3 mins | Views 17394

As humans we are all susceptible to taking emotional decisions which often are based on 'knee jerk reactions to a situation rather than on a calculated well thought out plan. You probably unknowingly encounter this every day in your life.... from hurrying to make purchases you probably do not need in times of heavy sales to buying sub-standard items whilst falling prey to marketing gimmicks such as ‘one day only’ price slashes. Decisions you are most likely to regret later!

When emotional decision-making effects trivial day to day decisions it most certainly could affect investment decisions which have an impact on our money. But is succumbing to such emotion driven decisions in your investing journey wise? Its often said that markets react to noise in the short term – Do you find yourself falling prey to this ‘noise ‘as well?

What is this ‘noise’ in the context of the stock market?

In the era of social media today, we are bombarded with and often over-exposed to chunks of information each day – on news channels and apps, social media, and the like. Noise is any news or alleged event or price fluctuation that triggers sudden volatility in the market. Noise is most often a result of hearsay or conjecture and very often may not be credible and unsubstantiated.

A circulating ‘news’ for example of a loss of a significant overseas contract by a reputed company can trigger panic selling by investors in the fear of a collapse of the company. On the other hand, an alleged bagging of a large government contract can cause over inflation in price and a clammer to buy over-valued assets.

Such ‘noise’ can create fear, panic and in reverse cases unnecessary optimism in investors. Fear of losing money or greed to make a quick buck off the market triggers emotional investing and most often panic and hurried decisions. These decisions are most likely to be simple knee jerk reactions rather than well thought out ones.

Should you pay heed to it?

It is common knowledge today that equity-based investing is for long term investors. This often makes such investing a patient waiting game. Reacting to noise in the short term in the market can be detrimental to your portfolio.

  • Liquidating investments at a loss

    Panicking and liquidating investments when prices are falling in reaction to short term ‘noise’ may cause you monetary loss on your investment money. Short term volatility can often be tided over if you persist with investments over a long term.

  • Lose out on power of compounding

    Mutual fund particularly Systematic Investment Plans(SIP) aim to help with the power of compounding in long term. Liquidating investments held for a short period means you lose out on the inherent feature of power of compounding which may have the potential to grow your portfolio further over the long term.

  • Higher tax implications in case of gains

    Even if your investment has grown, taking panicked decisions and liquidating them in a short period in reaction to ‘market noise’ can cost you in tax terms. Short term gains on investments are subject to significantly higher rates of taxes than long term capital gains on the same investments.

How can we avoid it?

With the plethora of information out there, how can you avoid falling for unnecessary ‘noise’ in the short term?

  • Know the difference!

    It’s important to note the difference between pure ‘noise’ and actual relevant information. Weeding out what’s relevant to your investments from what’s just ‘noise’ is key. Considering the source of information and its authenticity is important here.

  • Avoid over-monitoring your portfolio

    Being anxious and monitoring your portfolio on a daily or weekly basis is often unnecessary. Equity based investments should be given their time to grow. Micro-managing of your investment Net Asset Values (NAVs) can put you into panic mode on the slightest fall making you more susceptible to reacting to market ‘noise’.

  • Analyse only where necessary

    Avoiding noise however does not mean you turn a blind eye to authentic information. For example, a calculated credit downgrade or an announced government policy of an export ban on certain products can actually have an actual long-lasting impact on your portfolio. So, analyse and assess where necessary, but do not over analyse unnecessary noise.

Just as we shut our ears or shut our doors and windows to block out unnecessary noise pollution, a similar strategy could be followed to keep out market ‘noise’. Having a robust financial plan and sticking to it can help you to keep you insulated from knee jerk decisions. Look to modify your plan only when an event or activity necessitates it and not simply because it may seem so in a volatile short-term scenario.

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