Reviewed by Oct 05, 2020| Updated on
In the financial market, negative feedback comes from a trend of an adverse behaviour of investment. An investor who is making use of a strategy which is based on negative feedback will go on to purchase stocks when the prices plummet and put their stockholding for sale when the prices shoot up, which is not the same as most people would do.
The negative feedback will help in making markets less volatile. The opposite of negative feedback is positive feedback. In positive feedback, the strategies make the price shoot up to increase further, and prices fallen fall even more.
On the level of an individual, negative feedback may point to a trend of behaviour in which an adverse impact, such as suffering losses in trading, cause investors to raise concerns over their trading skills and dissuaded them in continuing the trade. Designing a rational plan of trading and being with it may help an investor maintain confidence and stay away from falling into a negative loop of feedback despite losing most of his trades.
Most people think that financial markets are capable of exhibiting behaviours of feedback loop. Initially, it was designed as an idea to explain the principles of economics, the concept of feedback loops are now commonly found in other financial areas, including capital markets theory and behavioural finance.
Negative feedback in finance can take on massively higher significance at times of distress in the markets. Provided that humans generally overreact to fear and greed, financial markets have behaviour, typically, to go random at times of uncertainty. The panic that sets in at times of a steep market correction illustrates this point.
Even for good things, negative feedbacks will become a negative repeating loop or cycle that will go feeding itself. Other investors who see those in panic, will, in turn, panic and create an environment which will put the entire system into distress.