Understanding “Market Noise”

In the world of trading, it is generally recommended that you avoid trading against the main market trends. However, it is not uncommon for financial markets to be volatile and for market noise to disrupt a trader’s analysis.

What is market noise? Where does it come from? How do you distinguish it from actual trend movements? What are the best techniques for filtering out market noise? Here are some answers!

What is market noise?

Market noise generally refers to various price changes over the short term that do not significantly impact underlying trends.

These price fluctuations may be the result of announcements, rumors, geopolitical events, or other news. They could also be created by high-frequency trading robots.

Just like static on a telephone line ruins a conversation, market noise does the same; it does not provide any useful information to the trade but complicates a trader’s ability to analyze.

How do trends help avoid market noise?

Market noise can harm traders by encouraging them to make impulsive decisions based on short-term price fluctuations rather than long-term trends.

That is why it is critical to be able to identify an asset’s underlying trend.

A trend in the world of trading generally corresponds to the overall direction of a financial instrument based on the general opinion of investors.

There are three main trends.

• Upward trend. In this situation, the prices form successively higher and higher peaks and troughs.
  
• Downward trend. The prices form successively lower and lower peaks and troughs.
  
• Neutral trend. The price of an asset moves laterally between two price levels called support and resistance.

Knowing the main trends of an asset helps you ignore the market noise, make more informed trading decisions, and avoid trading against the trend.

However, even while focusing on long-term trends, traders can take advantage of market noise when it leads to corrections. This makes it easier to recognize the direction of the trend and pinpoint the right moment to trade.

Should you set up an analysis with multiple units of time to reduce market noise?

The shorter the unit of time used to analyze the markets, the greater the market noise. Short-term price fluctuations (charts in minutes, seconds, or ticks) are, in fact, often heavily influenced by random factors. 

And these can trigger swift and unpredictable price fluctuations.

On some charts with longer units of time (days, weeks, or months), price movements are more even, and better reflect the general market trend.

How do you filter out market noise from your trading?

Renko Charts

Renko charts are Japanese charts that focus solely on price movement. The goal is to find trading opportunities in line with the main trend. Disregarding time helps filter out market noise.

Prices are represented by bricks of equal size, which appear one above the other at 45 degrees. The boundaries of these bricks are based on a price movement for which you have determined the breadth rather than a specific unit of time.

The size of the brick should be determined by your trading style as well as the volatility of the financial asset. The Renko chart ignores periods of horizontal consolidation and reveals the trend of the financial asset. 

Therefore, it is useful in quickly and unambiguously displaying the basic trend by focusing only on significant price movements.

Heikin-Ashi Charts

These charts are often considered an improvement over the classic candlestick charts. They help you filter out some of the volatility.

For each time span, the Heikin-Ashi charts factor in the average prices for the opening, closing, and high and low. This method of calculating lets you display smoother-looking candlesticks.

These filter out the short-term market noise and better reflect the underlying market trend, allowing you to chart trend strength and key price levels more easily.

Kagi Charts

This manner of depicting prices is also based on price, not time.

Vertical lines are used to show upward price movements (green or thick lines) and downward price movements (red or thin lines) based on the extent of these movements. 

The lines are connected only when the price reaches a certain level of variation, allowing you to see trends and reversals better.

As with Renko charts, you will need to set a limit or reversal threshold (for example, a percentage, price, or pip amount). The vertical line will change direction when prices exceed this limit (up or down).

Kagi charts make it easier to see long-term trends and avoid being distracted by minor price fluctuations.

Zig Zag

Zig Zag lets you reduce the impact of random price fluctuations based on your chosen parameters. This is a level of change that does not consider price fluctuations.

The technical indicator lines only appear when the price movement between a high and a low is above a specified level, often 5%.

Zig Zag lets you see the main trend better by filtering out price movements.

Technical indicators show trend strength.

The ADX indicator (Average Directional Index) and the DMI indicator (Directional Movement Index) are used in technical analysis to evaluate the strength and direction of a trend.

The ADX measures trend strength.

A score greater than 75 indicates extreme trend strength. A score between 20 and 40 generally indicates a new trend.

The DMI shows trend direction.

It consists of two lines, DI+ (Directional Indicator Plus) for an upward trend and DI- (Directional Indicator Minus) for a downward trend.

This makes it easier to focus on significant price movements and ignore the rest.

Beginning traders often make the mistake of focusing too heavily on short-term units of time in order to turn a quick profit, as you do in scalping or day trading on 5 or 15-minute charts. 

However, longer units of time could be helpful in identifying trends and the general opinion of the market because they filter out market noise.

Other trading tools and indicators could help filter out market noise, including Renko, Heikin-Ashi, and Kagi charts, Elliott Waves, and Zig Zag, DMI and ADX indicators.