The tipping point of Netflix’s stock
https://www.economist.com/democracy-in-america/2011/10/26/information-cascades
The Economist article starts with an observation of the stock prices of Netflix — it’s very volatile. 18 months before the article was written, the price went from $50 to $300 then all the way down back to $75. Not only has the price gone through a rollercoaster, even more surprising is that on its way up and down the curves look very smooth, meaning that it was moving in one single direction for over 8 months, then suddenly one day, changed its direction, and plunged for 4 straight months.
The graph of Netflix’s stock price is quite different from what we’re used to see in stock market charts. Usually they go up and down frequently, and even when there might be a rough trend based on the industry or the prosperity of the firm, still they fluctuate a lot. So what make Netflix’s chart so distinctive? The article argues that it is because of the information cascade effect. Information cascade effect means that people make decisions based on their observation of other people’s behaviors. Instead of making decisions on themselves based on collected information, people follow what others do. Of course such following has some innate advantages, such as other’s behaviors might reflect private information that we don’t know, as we learned in our lectures. However, in Netflix’s case, it can lead to very extreme outcomes.
People buy stocks at low prices and sell at high prices. So when a stock is going up, there are people who are satisfied with what they’ve earned and sell it, which drives down the price; and when a stock is going down, some people don’t want to bear any more risks and sell them, which drives the price up. Thus stock fluctuates regularly but are usually near some benchmark which is decided by the prosperity of the industry or the firm. However, in Netflix’s case, people don’t make decisions based on “real information” of this firm. Netflix’s streaming service at that time was just a start, and people weren’t sure about its profit model. They just knew that there was this super hot company which was changing the whole cinematic market, and they better got on this train. So when the stock of Netflix went up, everyone followed the trend and bought more shares. Normally after the price went up for a while people would start selling. But seeing the craziness of the chart, no one wanted to back out first. Until it reached a tipping point where someone decided to sell it. Then the cascade effect caused everyone to follow these first people. Especially since Netflix doesn’t have physical properties, people couldn’t figure out what the company’s real evaluation is. So driven by cascade effect, the stock price went all the way down to almost where it started 18 months ago.
Such trends in the stock market is dangerous. With lack of information about the company, but more information than ever about other people’s behaviors around this company’s stock, such cascade effects can happen more easily. And it can extend to the larger portion of the market, where the whole market’s valuation goes up too fast during the boom, and goes down too fast as well when rumors of financial predicament starts. Perhaps if more people take a networks class during college, we can all enjoy our lives with more peace of mind.