Have you ever wondered why do you even choose to trade this stock? Or what makes you want to trade that? If you fail to find the sound fundamental of those questions, then you might be suffering from bandwagon effect.
If, by any chance, you are suffering from the bandwagon effect, what is the big point? What is its significance and how does it affect your trading? To answer the foregoing, let’s examine the topic more thoroughly.
Also Read: How Confirmation Bias Affects Your Trading
What is the Bandwagon Effect?
The bandwagon effect explains a cognitive bias when a person does a certain activity primarily because others are doing it. Also known as herd behavior, the person suffering from it chooses to follow what the crowds do and, in the process, invalidates the very own self-judgement and analysis.
In trading, the effect is vividly noticeable when a stock price suddenly skyrockets without even any definite basis. Most of the cases happen during bull markets. Also, this behavior of trade is a good instance of George Soros’ reflexivity.
How Can the Bias Affect Trading?
This cognitive bias affects trading significantly in a way that it potentially negates one’s own analysis simply because the majority is doing it. For the record, it is essential to note that what majority does is not always the most advantageous thing.
To accurately illustrate it, the dotcom bubble happening in 1990s is arguably the best example. It was the time when investment in the Internet increased rapidly in the US and many investors made investment in it just because others were doing so. However, by 2001, it all went wrong.
How Can You Possibly Avoid It?
Despite everything, there actually exists a simple way to avoid this phenomenon. Considering that it happens due to simply following the herd, the way to avoid it is stop following what others do unless it is proven beneficial.
In so doing, it is always of importance to consult to your data and analysis. Some strategies to buy rumors and/or news are helpful so long as they have strong justification. It, therefore, becomes a personal rule that any trader should implement.
Also Read: Anchoring, a Subliminal Cognitive Bias in Trading
