Noise Trader Manifesto - Trading systems and market timing manifesto for stock market, futures and currency trading.

Tribes (Agents)

The land of Wall is a collective of mind. In this virtual universe the desire (bids) and loathing (offers) for things resolve into transaction prices. Prices move violently from place to place, and quietly in place (jump-diffusion).

Price is a transient location in time. Those coordinates are measured in a vertical dimension as price itself, and in a horizontal dimension as time. Traders stare anxiously through liquid crystal to fathom the transient location of price – and to divine its future location. In the land of Wall , the movement of price is the obsession of all.

Price absorbs and processes information and the movement of price (effect) is attributed to market events (cause) which increases or decreases the desire to hold inventory. But, there is a great ongoing debate over how market events should be measured and analyzed, and which market events are meaningful. Observations are filtered through a technical, quantitative or fundamental lens and then synthesized into decisions to buy or sell.

Four trading tribes have coalesced in the land of Wall . They differ in how they apprehend the nature of information and how they perceive the information content of market events.

A. The tribe of Mo (momentum traders) seeks to exploit inefficiencies in the propagation of information. They labor to buy or sell before a market event is fully realized in price and liquidate into that realization.

In the chart below, a Mo tribesman initiates a buy anticipating that a emerging market event creates a buy-side order flow imbalance sufficient for price to escape the gravity of current equilibrium and to rise to a new equilibrium level where profits can be extracted. Mo elders may be more inclined to hold inventory over time, than the young and the restless.

There are two seasons in Wall, but they are aperiodic. During Delta periods the value of a thing is sensitive to change and the vertical dimension is dominant. Delta is a period of inefficiency or directional movement (trends) where price is unbounded and non-random.

During Rho periods the horizontal dimension is dominant and price is constrained in a trading as an irregular data mass moves toward efficiency.

The Mo prosper during seasons of Delta (vertical dominance; trend runs), but are scattered to the winds during seasons of Rho (horizontal dominance; trading ranges)

B. The tribe of Val (value traders) base their existence on their belief that the volatility of price is greater then the volatility of value. They exploit market events that offer inefficiencies in valuation. They strive to buy a price too low (below value) or sell a price too high (above value) and they liquidate upon a reversion to value (see below).

The Val prosper during seasons of Rho (horizontal dominance; trading ranges)but are scattered to the winds during seasons of Delta (vertical dominance; trend runs).

C. The third tribe, is the lost tribe of the Noise trader. The composition of the Noise tribe is constantly changing as members of the Mo and the Val both migrate into this tribe. Recall that the Delta and the Rho seasons are aperiodic, so those who have misread the transitions between seasons and their trade location in it, are trading on noise as if it were information.

In the chart below, a Mo trader initiates a short anticipating that a certain market event may attract sufficient offers to allow price to escape the gravity of current equilibrium and to trend lower to a new equilibrium level.

If the information content of that event is already low or depleted, if the market event is already efficiently discounted, then the Mo tribesman is trading on noise as if it were information and becomes an active member of the lost tribe of the Noise and is forced to cover higher at a loss.

At the same time, a Val may view this as a price too low and take the other side of this trade. In this case the Val possesses superior information and a transactional advantage.

In the chart below, a Val seeks to exploit a transient inefficiency in valuation by initiating a short at a price that he/she believes is too high. The Val anticipates that the observed deviation above value will shortly revert to equilibrium.

But, if price is in the process of moving to a new higher equilibrium level, the Val tribesman has misread the price action and is forced to cover his short at a loss. Here, the Val is trading on noise as if it were information and becomes an active member of the lost tribe of the Noise.

At the same time, a Mo may view this as the beginning of a Delta period and take the other side of this trade. In this case the Mo possesses superior information and a transactional advantage.

And there is evidence of the existence of a fourth tribe, the Formless -- passive observers, who seem to act on the evidence of things unseen and move swiftly and in large size in the presence of noise traders. The Formless apparently hold to a strange constellation of dichotomous beliefs.

They believe that market readability and reliability is often incompatible -- meaning that what is obvious (easy to notice, easy to read) in a market, is often unreliable and dangerous. They claim that what is not happening in a market has more information content than what is happening.

They believe the impulse toward efficiency is an unrelenting force, always present, always active, always seeking to gain horizontal control, to bring an irregular data mass to efficiency. They aim at effortless execution, so they strive to act only when consistent with market purpose which they claim is for price to move to efficiency.