Are You A Trader Who’s Victim To The Bandwagon Effect? 1
People believe in something simply because other people believe in them.
Which really is another way of saying that market participants (and people in general), have a strong tendency to engage in herd behavior, also known as the bandwagon effect.
7. Bandwagon effect
While financial history is replete with investors’ stampeding to buy (or sell) a specific asset together, we don’t have to look too far back in the past to find good examples.
Last year’s stock market rally from April 2020’s lows to making multiple all time highs this year is a good demonstration of traders all rushing to do the same thing at the same time.
In this case, the common belief was that stocks “can only go up” because Central Banks won’t stop “printing money”.
However, regular readers will be aware that QE isn’t money printing, which means that the main reason that stocks “can only go up” is because everyone believes so and keeps buying!
Naturally, this cannot end well for the folks who blindly jump on the bandwagon and stuff their accounts full of long equity positions.
Because at some point, the narrative espoused by the bandwagon is no longer able to attract as many new buyers as it could before, which leaves previous bandwagoners with no one to sell to.
Going a little further back from 2020, we have the first Crypto Craze, which lasted for two years, from 2016 to 2017. This initial frenzy saw the price of BTC spike from around $500 to about $20,000 as traders rushed to jump on the Cryptocurrency bandwagon.
There were, and still are, many Crypto investors who believe that Cryptocurrencies are a long term investment due to their potential to massively disrupt and even replace existing monetary systems.
However, many were buying BTC simply because they believed it would “keep going up”. (This sounds awfully similar to 2021’s “buy equities” narrative, doesn’t it?)
Unfortunately for these bandwagoners, Bitcoin fell from its dizzy $20,000 peak to about $3,200 over the next two years.
Needless to say, a lot of folks lost a lot of money.
Of course, we are now in the second Crypto Craze, which began in 2020 and seems to still be ongoing. BTC has gone from a low of about $3900 to a high of about $65,000, dwarfing the dizzy heights of 2017.
Clearly the Crypto bandwagon is back, and this time in much larger numbers.
This isn’t to say that Cryptocurrencies do not have long term value, or that they don’t have the potential to drastically change the monetary landscape. But, the bandwagon effect in Crypto also doesn’t provide definitive evidence in favor of both these opinions.
What it is definitively demonstrative of, is our human tendency to fall prey to the bandwagon effect.
To be continued…
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