Information Cascades in Stocks
The concept of information cascades can be readily observed in today’s stock markets. There are individuals who will conduct their own private research about companies and look at data from the past to conclude certain market trends, but most people have neither the time nor the technical skill to predict which investments will be the best. In these cases, they may not trust their own judgement and will instead look to see what other people are doing. Perhaps one person will follow the advice of a money manager and later discuss her findings with her co-workers, who will then proceed to follow the same advice, thus starting an information cascade that was based on the predictions of a so-called “expert.” This information will continue to be passed on, and each individual is likely to deviate from their own research because they believe that the herd probably knows better than they do.
In order for this kind of cascade to be beneficial, the initial source of the information must be confident in his or her own findings because the decisions of everyone that reads their advice will be influenced. The fact that so few sources of information can create such an impression on a large group of people is one of the dangers of information cascades. If the initial “expert” was wrong, then everyone that followed their advice was led astray. Because of how fragile and fickle these cascades can be, it is wise to not trust trends at face-value.
In addition to not receiving false information, it is a good idea to not follow the herd when investing in stocks because of how volatile trends can behave. They come and go often, and it is generally not a good practice for an investor to constantly buy and sell assets in only the newest and most recent stocks just because they hear other people investing in them too. To avoid the pitfalls of information cascades, the best thing one can do is perform their own research.