Evidence of the Bandwagon Effect in the Stock Market
As technical as the stock market may be with modern computers, significant movement can still occur based on emotion, hearsay and panic. Both professionals and mom-and-pop investors can all succumb to the siren's song of joining the investment bandwagon, even when it ends up going off a cliff.
Other People Are Reading
-
The Fickleness of Retail Investors
-
The mom-and-pop stock investor or retail investor represents someone looking to make their personal savings go a little farther with some side gambling on the stock market. While these folks will frequently follow programs preaching how-to research, many react immediately to the news or what their friend says when trading stocks. As a result, while this group of investors can move upwards of $30 billion per month in payroll deduction investments, for example, they frequently follow trends hoping for quick gains.
Last to the trough and the first to lose, many retail investors chase into a panic rather than avoid it. The results are seen both in the high-priced buying of stocks in 2007 to "get into the market before it's too late" and the late selling of stocks in March 2009 when the market was at a long-time low compared to previous years.
Intra-Day Trading Stress
-
Unlike retail investors, intra-day trading involves highly technical trading. Frequently using software and automation, the goal of intra-day traders is to buy and sell a position in the same day at a profit. Many times trading positions on share movements worth pennies per unit, these traders can get worked into a frenzy as split-second information moves like fire on kerosene via word-of-mouth or more often text-by-Internet. In some cases, intra-day traders can move in a market mob mentality just like retail traders; however, they do so in mere moments and within the same day rather than months.
-
The Cramer Effect
-
Throw in a popular TV spokesperson with charisma and a funny noise-making gimmick, and you get the Cramer Effect on the stock market. Jim Cramer, host of MSNBCs "Mad Money," cut his teeth for years as a stock trader, so he has professional credibility. But he has also clearly been able to repeatedly move the market on specific stocks with his nightly recommendations of what to buy and sell.
Although Cramer regularly preaches that viewers should do their own research, the mass audience is frequently lazy and takes his word immediately as gospel truth. This behavior, dubbed the "Cramer Effect," results in specific stocks realizing short-term rises or drops in value depending on the TV discussion the night before.
It should be noted: Cramer's total annual picks haven't always had a positive net profit, but usually do.
Automated Trading
-
Another creation of modern technology in barnyard market behavior remains software-driven trading. The most recent example of this problem showed up in early May 2010, when one trader inadvertently made an input error. This sent off a panic-wave of alerts through other watchful trader systems. The error resulted in a domino-effect of 10.5 billion plus units of shares being sold off in a split-second before market regulators temporarily halted trading. Regardless of the error being identified, the remaining days suffered additional market losses after trading jitters set in the first day.
So why have an automated system then? Many institutional traders swear by them because they can make pennies of profit on each share. When trades involve thousands of shares per moment, this becomes good money fast. But like a house of cards, automated alert triggers can backfire too.
Government and the Federal Reserve
-
The federal government can also contribute to "bandwagon" trading. Particularly with the Federal Reserve, when government prognostications are made regarding the immediate future of the economy, traders listen as a group to reposition for future booms or recessions in industry sectors. This is why every time the Fed announces an interest rate change, the stock market tends to rise or drop the same day.
-
References
Resources
- Photo Credit stock exchange image by Christopher Walker from Fotolia.com
