Warren Buffett the Investing Genius
Warren Buffett, one of the world’s richest people, is often considered a guru in investing and trading stocks. He has attracted the attention of millions of investors who also wish to command the same investing knowledge and magic touch he has. There are even many who simply follow every investment move he makes. It is intriguing that one person can influence so many people’s decisions regarding their livelihoods.
The way people follow Warren Buffett’s every move could be viewed as an information cascade. Let us consider a simplified model where a person must decide whether or not to buy a stock. They want to buy the stock only if they believe that the stock will make money and they do not want to buy it if they believe that it will not make money. Each person will make their decision sequentially, based on the information they have. Additionally, let us say that Buffett has significantly “more knowledge” of the state of the stock because other people believe he does.
To start the cascade, Warren Buffett will decide first whether to buy the stock or not. Whatever choice he makes, the people who decide after him will tend to ignore their own private information and follow his decision because they know that Buffett made his choice based on the private knowledge he has which is greater than their own and since they don’t know anything about anyone else’s private knowledge.
Now let us consider the case where Warren Buffett decides after a few people decide. Those few people will decide according their personal information and the choices of others. When it is Buffett’s turn, he will most likely follow his own personal information because the amount of knowledge the few people have is insignificant. Whether or not there was an information cascade from the few people before his decision, Buffett will most likely cause an information cascade based on his decision. As a result, the people that decide after Buffett will follow his decision just like in the other case.
Although this is a very simplified model, Warren Buffett’s decisions in the stock market do create information cascades. People imitate his decisions solely on the fact that they believe that he has more knowledge. His influence is so great that it even causes the price of a stock to go up if he has invested in it. Consequently, his reputation goes up, he becomes more legendary, people follow him more, and the cycle repeats itself.
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Source: http://abcnews.go.com/Business/invest-warren-buffett/story?id=16662763#.UKICaKWmDdk