How Information Cascades Factor Into the Stock Market
https://www.investopedia.com/articles/investing/052715/guide-understanding-information-cascades.asp
As someone interested in trading stocks for close to a decade, I can confidently say there is no proven formula for success. Sure, some people have developed algorithms and conceptualized patterns the best they can possibly be understood which has to lead to consistent success, but even then there is potential for failure. It’s an educated guessing game that in my experience, leads to people seeking any counsel or information that could give them an edge. Sometimes people will sacrifice their own thoughts and predictions for someone else’s just because of some misperceived credibility. This very point about the stock market and its occupants is what makes the topic of information cascades so relevant.
The article I chose first details what information cascades are and how they function. The general idea is that a cascade forms when a person makes a decision based on others’ decisions, disregarding their own knowledge. It further discusses the key characteristics of this phenomenon. One is herd behavior where there is limited information available and people just start believing the majority cannot be wrong. This is essentially a mob mentality where people see and majority and follow. Another is fragility which brings a different quality to the pattern. The fragility of information cascades implies that any new information can heavily alter people’s actions. Transitioning into a real-life application, the article discusses how this principle is applied in financial markets. First, as I referenced in my own analysis of financial markets, the general public will commonly believe that a financial pundit has more knowledge than they do so will base their decisions on their word. It also doesn’t have to be an official source that starts a trend. It can often be the word of a friend or neighbor that promotes the pattern of investments. When the initial source is unreliable, this can lead to a lot of financial backlashes.
The idea of information cascades has been deeply explored in class as of late and as demonstrated in the summary of this article, financial markets do greatly resemble information cascades. I think information cascades are a helpful representation of human behavior. Mob mentality is so prevalent in all walks of life and when it is represented in a model as such, it makes things like the stock market easier to understand. In Robinhood, there is a section when you click on a stock called the analyst rating which basically tells you whether to buy the stock or not. I imagine most users see this and act on its advice. Why wouldn’t you? It’s an ‘analyst’s’ report that is based on fact. Yet, features like these are what create the mass information cascade. It will start with some people buying and then telling others to follow. No matter what these people’s opinions are on the stock, they will likely blindly follow others.