Categorized | Stock Trading

Bandwagon Effect and Its Implication in the Investment World

In its simplest definition, bandwagon effect refers to situation where people do certain things because many others are going the same direction, even when their instinct tells them otherwise. Perhaps you’ve witnessed the case of several people ‘getting on the bandwagon’ of popularly demanded products. This concept also affects our investment decisions.

An Example of How Bandwagon Effect Works in Investment

For instance, ABC Computers launches a mobile phone that suddenly became popular among superstars because of its ‘hippie’ features. As a result, many investors buy ABC computers’ stock, concluding it’s a thriving company because of the popularity of its newest product. As the news about the increased demand of this company’s stock spreads, the stock witnesses even further demand until almost everyone starts demanding for ABC computers’ stock. This is a typical scenario of bandwagon effect in stock trading or just any investment decision.

So, people don’t bother to research further but plunge into the stock purchase trend because of popular demand or what others are saying about the company and its stock. This concept transcends beyond the financial markets, it is also a social phenomenon seen easily in many other scenarios.

Why Does the Bandwagon Effect Matter?

In investment decisions, the bandwagon effect is potentially unsafe and results in opportunity creation. In our example above about ABC computers, the increase in demand will eventually drive the company’s stock price upwards, even far beyond what it is truly worth.

On the other hand, rational investors would rather go for the stocks that tend to be unpopular (not joining the ‘bandwagon’ but rationalizing extensively and would not hesitate to go the opposite direction when they find out otherwise about what the rest of the people think towards an investment opportunity.

So, which investor are you, the ‘bandwagon effect’ investor or the rational investor? It is better to rationalize reasonably before making an investment decision.

Be Sociable, Share!

Leave a Reply