What Is Negative Feedback?

Negative feedback can be defined as a system where outputs mute or moderate the initial inputs, with a dampening effect. In the context of contrarian investment, an investor u🌠sing a negative feedback strategy would buy stocks when prices decline and sell stocks when prices rise, which is the opposite of what most people do. Negative feedback, by this definition, helps make markets less volatile by pushing systems towards equilibrium.

Its opposite is 澳洲幸运5官方开奖结果体彩网:positive feedback, in which a good outcome is perpetuated, or when herd 🍷mentality pus♚hes elevated prices ever higher.

Negative feedback is also used colloquially (although it is technically incorrect) as a system where outputs are routed back as inputs to exacerbate some negative outcome, thereby worsening a bad situation, such as an economic panic or a 澳洲幸运5官方开奖结果体彩网:deflationary spiral. This use is technically incorrect as it is an example of a positive feedback loop that makes a negative outcome worse. Still, many people (incorrectly) use the term negative feedback l🙈oop in this context.

How Negative Feedback Works

Many people believe financial markets can exhibit feedback loop behaviors. Originally developed as a theory to explain economics principles, the notion of feedback loops is now commonplace in other areas of finance, including 澳洲幸运5官方开奖结果体彩网:behavioral finance and capital markets theory.

With negative feܫedback, events like stock price drops, bearish news headlines, social media rumors, and shocks produce reactions that serve to stabilize or reverse that initial result. Dip buyers or profit-taking sellers, for instance, can help minimize the severity of a selloff or rally.

This differs from positive feedback, where input from a relatively minor initial event can snowball into an ever-compounding downward spiral. Financial panics and market crashes are examples of positive feedback in markets that head i🐓n the negative direction. Bubbles are positive feedback loops that instead send prices higher.

Special Considerations

Feedback within financial markets takes on significantly greater importance during periods of distress. Given humans' propensity to overreact to greed and fear, markets have a tendency to get erratic during moments of uncertainty. The panic during sharp market corrections illustrates this point clearly.

Such feedback, even for benign issues, becomes a negative self-fulfilling cycle🐭 (or loop) that feeds on itself. Investors, seeing others panic, in turn, panic themselve💛s, creating an environment that is difficult to reverse.

However, many markets are restored to some sort of 澳洲幸运5官方开奖结果体彩网:equilibrium through negative feedback. Arbitrage, 澳洲幸运5官方开奖结果体彩网:value investors, and spread traders all seek to profit from mispric🧸ings generated by positive feedback loops by taking opposing position🅷s to the emotional response.