Information Cascading, Herd Effect, and the Stock Market
The stock market is truly a phenomenon that people spend years trying to study; prices change everyday and the underlying factors are plentiful and volatile. However, a huge indicator of how prices and the market itself moves, entails the actions of specific investors, and how they are influenced by those around them. There is a huge inclusion of the herd effect and information cascading involved with the direction of the stock market, and it is essential to address this when evaluating the market as a whole.
Many seem to focus only on the internal details of a company when evaluating what affects their changes in price. This can include M&A activity, new developments, losses, and more. However, many investors actually focus on the actions of those around them when making their own investment decisions. For example, extremely popular stock such as Google and Apple are consistently invested in by uneducated investors; they believe that because they hear a lot about these companies and their performance from those around them, and see others investing, they are more motivated to do so. Many people do not understand the inner workings of the stock market; instead, they rely on the ears and actions of those around them in order to influence their own decisions, creating a clear example of information cascading and the herd effect.
An interesting point here though is that those who do fall for the information cascading and the herd effect, are generally the investors who are the least successful. Warren Buffett, whose investing reputation precedes him, clearly states that people should refrain from investing in stocks or projects that they don’t understand. However, the fact that the average person has such little understanding of how stock prices truly move, leaves the door open for this information cascading and herd effect to occur. It is actually those investors who have diversified portfolios along with a strict game plan that end up being the most successful. However, since the information being spread around about stocks and companies is what pulls so many people and investors into the stock market in the first place, this information cascading does play an essential role in the market. A number of uneducated investors who follow each other and the crowd, and ultimately invest heavily in one company can push that company’s stock price up, based on demand; the vice versa can also occur. Overall, it’s incredibly intriguing to evaluate how much influence and still how little information the majority of people have about the stock market, making it clear that these network impacts of the herd effect and information cascading play a huge role.
https://www.investopedia.com/investing/steps-successful-investment-journey/
https://economictimes.indiatimes.com/slideshows/investments-markets/10-golden-rules-of-investing-in-stock-markets/1-avoid-the-herd-mentality/slideshow/18570964.cms
https://www.fidelity.com/viewpoints/investing-ideas/six-habits-successful-investors