How to filter out market noise?

Education

Looking at the ways one can take in order to look past the ‘noise’

When it’s too
noisy, you often can’t make out what you want to hear. You may get confused and
do something wrong. The same thing can happen when you trade currencies as
technical analysis can be complicated by the so-called ‘market noise’.

This term refers
to random fluctuations of the price – those that don’t have any logic or volume
behind them. The negative effects of price noise include false entry signals,
drawdowns, and errant triggering of stop loss orders.

As a result,
it’s only natural for traders to be in the constant search of ways if not to
remove the market noise entirely, then to make its detrimental impact as small
as possible. Let’s review the most popular methods of avoiding market noise.

First of all, if
we go with trend trading as the basis of our strategy, we can actually consider
movements inside a trade channel as market noise. The natural course of action
is entering a trade at the trendline in the direction of a trend.

The market noise
is in the inverse relation to the degree of the timeframe: the bigger the time
period of the chart, the calmer is the price. For example, the daily chart is purer
and can provide a better understanding of the overall market situation than
1-hour timeframe.

In other words,
the right choice of a timeframe at least partially helps to remove the market
noise. The rest is up to the trader himself/herself and his/her skills.

Next, we switch
to technical tools that may give us a hand dealing with market noise. These
tools will help to focus on the trend and track it for a longer period of time.
The first tool that comes to mind is also the simplest one – a Moving Average.

Price swings
around this line can be interpreted as noise. The bigger the MA’s period, the
bigger the range of fluctuations. The MA allows focusing on the important thing
– the direction of the trend – and disregarding minor moves in expectations
that the price will return to the mean and progress in the direction of the
main tendency.

A trader has to decide,
whether he/she will consider these smaller countertrend moves for his/her
positions.

Another
indicator is ZigZag. Its function is to mark the significant price swings on
the chart. A trader can set a level of ZigZag’s sensitivity through a number of
parameters. Price fluctuations which are below the indicator’s sensitivity
threshold won’t be highlighted on the chart.

Thus it’s
possible to ignore them in the analysis. In addition, ZigZag helps to locate
support and resistance levels, identify trends and chart patterns, and find
good locations for stop loss orders. It can be used together with other tools
and indicators such as Bollinger Bands, fractals, Fibonacci, and Elliott waves.

The main drawbacks of ZigZag are that it marks
the latest extreme point of the chart with a lag and that its last stretch may
get redrawn as the current price changes.

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ForexLive

The combination of
Japanese candlesticks and moving averages gave birth to an indicator called
“Heiken Ashi”. Its formula readjusts traditional candlestick chart using
averages. The resulting chart doesn’t include smaller price fluctuations and
allows judging the trend’s strength. It’s wise to combine Heiken Ashi with
other indicators, for example, ADX or Stochastics.

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Renko is another
alternative to the ordinary Japanese candlestick chart. The most peculiar thing
about it is that it doesn’t consider such parameter as ‘time’. A ‘brick’
appears at the Renko chart only when the price covers a certain distance up or
down.

This lets a
trader concentrate solely on the price’s direction. By choosing which brick
size to set, he/she decides which movements of the price to consider
significant. If the brick size is small, it’s easier to spot price reversals.
However, there’s a chance that a miniature brick size will filter out too few
of the false moves.

Renko charts work well on intraday timeframes
and are especially popular among scalpers. Notice that Renko isn’t included in
MT4 by default, so you will need to download a custom indicator or an expert
adviser from the Internet.

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Conclusion

On the one hand,
fighting market noise does seem a bit like tilting at windmills. The fact is
that such movements of the price represent an inherent feature of the market,
and if you are a trader you won’t like having the market as your enemy.

On the other
hand, measures to diminish the influence of random price fluctuations are aimed
at bringing some order and harmony to market analysis so that it would be
easier to generate clear and profitable trade ideas. In that sense, the
techniques and indicators described above are quite useful and may form a solid
foundation of a good trading strategy.

This article was submitted by FBS.

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