Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Bandwagon Effect

What it is:

The bandwagon effect is when people go along with what everyone else is doing.

How it works (Example):

Let's say Fruit Computers launches a cellphone that is popular with hipsters. It even talks. Because the product is so snazzy, people begin to believe that Fruit Computers is a great company, and they buy the stock. At cocktail parties and boardrooms far and wide,  people are hearing about how so-and-so just bought a lot of Fruit Computers stock or how the latest analyst report says it's a good company. Everybody is a buyer of the stock.

This is the bandwagon effect. Without much research or homework, people buy the stock because they "heard good things about it" or "think it's a neat company." In some cases, they just want to look like they know what they're doing. They are going along with what everyone else is doing.

The bandwagon effect is not limited to the financial markets; it is a larger social phenomenon that applies in many situations.

Why it Matters:

In finance, the bandwagon effect can be very dangerous and it therefore can create a lot of opportunity. In our example, the huge buying activity drives up the price of Fruit Computers beyond what the company is legitimately worth. Contrarian investors, for example, like to do the opposite of what everyone else is doing, thereby capitalizing on things that other people overlook. In our example, they might start to short the stock once it passes a certain point (though they have to be prepared to be laughed at).