Separating Signal From Noise In Markets
There’s not much information to get. The most important variables in global macro are the economic conditions and how central banks respond to those conditions.
To get that information, I read the paper, look at the data, watch what the officials say, and try to read between the lines. From an actual trade point of view, it’s price action that determines when and where to put on a trade.
Otherwise, there’s a huge amount of noise in the world. Other people’s opinions are irrelevant. I can’t bear talking to salespeople because all they want to do is tell you something new, and things don’t change enough to warrant that. I don’t pick up the phone if I can avoid it.
– The Currency Specialist, from Drobny’s Inside the House of Money
My take: A big part of successful trading is learning how to effectively separate wheat from chaff and signal from noise.This is no easy task. We live in a world of 24/7 information flow. It’s easy to drown in the constant firehosing of data, opinions, and hot takes. Traders get into trouble when they mistake the noise for actionable intelligence. This happens because they don’t yet have a framework for which to filter out what’s useful and what’s not. All a framework is is a set of mental models, broad first principles, and general truths that you stress test for robustness and which hold up through time.The key is to start with the simple truths and build, slowly, while never sacrificing veracity for complexity. Munger gave a killer speech about how to do this back in the 90’s. Here’s a cut from it (emphasis mine).
Well, the first rule is that you can't really know anything if you just remember isolated facts and try and bang 'em back. If the facts don't hang together on a latticework of theory, you don't have them in a usable form.
You've got to have models in your head. And you've got to array your experience both vicarious and direct on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You've got to hang experience on a latticework of models in your head.
What are the models? Well, the first rule is that you've got to have multiple models because if you just have one or two that you're using, the nature of human psychology is such that you'll torture reality so that it fits your models, or at least you'll think it does. …
And the models have to come from multiple disciplines because all the wisdom of the world is not to be found in one little academic department. That's why poetry professors, by and large, are so unwise in a worldly sense. They don't have enough models in their heads. So you've got to have models across a fair array of disciplines.
You may say, “My God, this is already getting way too tough.” But, fortunately, it isn't that tough because 80 or 90 important models will carry about 90% of the freight in making you a worldly-wise person. And, of those, only a mere handful really carry very heavy freight.
For the Currency Specialist, the framework he carried was focused on a few global macro and economic variables, how central bankers responded to these conditions, and then constantly testing his resulting assumptions against the truth mechanism that is the market.At MO we apply a range of mental models from Capital Cycles to Investment Clocks to Game Masters and Liquidity Levers to name a few. Like the Currency Specialist, these models help us distinguish the signal from the noise while keeping us from chasing something shiny that’s of little value. And more importantly, it gives us a framework from which to value these inputs and our responses to them. This allows us to continuously refine our tools and mental models which hopefully drives us closer and closer to truth and profits. Market Wizard Michael Marcus said the most valuable thing he learned at Commodity Corp (CC) was how “to see the signal, like the signal, follow the signal.” Focus on developing your latticework of mental models and you’ll get better and better at seeing the signal. Drop any questions/comments in the comment section below. And if you’d like to get my thinking, ramblings, and occasional trade ideas, then just put in your John Hancock along with your email below.Thanks for reading, Alex
