What Is Negative Feedback?

What Is Negative Feedback?

Let me explain negative feedback to you directly: it's a system where outputs mute or moderate the initial inputs, creating a dampening effect. In contrarian investment, if you're using a negative feedback strategy, you buy stocks when prices decline and sell them when prices rise—which goes against what most people do. This approach helps make markets less volatile by pushing systems toward equilibrium.

The opposite is positive feedback, where a good outcome keeps building, or herd mentality drives elevated prices even higher.

People often use 'negative feedback' colloquially—but incorrectly—to describe a system where outputs loop back to worsen a bad situation, like an economic panic or deflationary spiral. Technically, that's positive feedback making a negative outcome worse, yet many still call it a negative feedback loop.

Key Takeaways

Understand this: negative feedback means outputs from a system feed back into it, minimizing or reducing the effects of later iterations. In markets, these loops reduce volatility through practices like contrarian or value investing. As an investor following this, you buy when prices drop and sell when they climb. Remember, though technically wrong, many refer to a self-perpetuating downward spiral as a negative feedback loop, but it's really positive feedback enhancing a bad outcome.

How Negative Feedback Works

Many believe financial markets show feedback loop behaviors, a concept that started in economics and now applies to behavioral finance and capital markets theory.

With negative feedback, events like stock price drops, bearish news, social media rumors, or shocks trigger reactions that stabilize or reverse the initial result. For example, dip buyers or profit-taking sellers can lessen the severity of a selloff or rally.

This contrasts with positive feedback, where a small event snowballs into a compounding spiral. Financial panics and crashes are positive feedback heading negative, while bubbles send prices higher.

Fast Fact

Warren Buffett often says markets are frequently nonsensical, unlike efficient market hypothesis proponents who claim they're always efficient. So, troubled stocks might price lower than you'd rationally expect due to panic or pessimism. If this persists, prices can drop below fundamental levels because of what people call a negative feedback loop.

Special Considerations

Feedback in financial markets matters more during distress. Humans overreact to greed and fear, making markets erratic in uncertain times. Panic in sharp corrections shows this clearly.

Even for minor issues, feedback becomes a negative self-fulfilling cycle that feeds on itself. When you see others panic, you might panic too, creating a hard-to-reverse environment.

But markets often return to equilibrium via negative feedback. Arbitrageurs, value investors, and spread traders profit from mispricings by opposing emotional responses.

Important

One way you can protect yourself from dangerous feedback loops is by diversifying investments. The negative cycles in the 2008 financial crisis cost millions dearly.

What Is Negative and Positive Feedback?

Many think financial markets exhibit feedback loops. Positive feedback amplifies change: as share prices rise, more people buy, pushing them higher. Negative feedback minimizes change: you buy when prices decline and sell when they rise.

What Is an Example of Negative Feedback?

A constant example is how your body maintains internal temperature. It senses a change like a temperature spike and activates mechanisms—like sweat glands—to reverse it.

What Is Meant by Negative Feedback Loop?

In financial markets, a negative feedback loop refers to behavior that compounds a bad outcome or minimizes change instead of amplifying it. In the minimizing case, investors buy low and sell high—but that's actually positive feedback, though many still call it negative.