7. Bandwagon effect

The most obvious answer is also the most damning one – laziness.

Most people simply refuse to think for themselves. After all, it is much simpler to go along with what everyone else is doing, or what our friends are doing, or even what internet strangers say will make the most money.

This laziness can in part be attributed to a misplaced faith in the “wisdom of the crowd”.

The “crowd” isn’t always wise, and it isn’t always right. If crowds always know better, then history won’t be littered with any instances of market bubbles – but it is.

Following the crowd also affords lazy individuals the perfect excuse: “I was just following along”, or “it’s not my fault, I was doing as I was told”.

Unfortunately, while these excuses may be psychologically comforting, they do not change the reality that while the advice may have been horrible, the losses aren’t borne by the advisors.

They’re borne by those who followed blindly.

Furthermore, such excuses actually act to perpetuate a trader’s propensity to fall for the bandwagon effect again.

This happens because in making these excuses, a trader is implicitly refusing to take responsibility for his own actions.

Failing to take responsibility means that he won’t be able to identify that a mistake was made (blindly jumping on the bandwagon). In this way, he dooms himself to repeating it again.

Another reason the bandwagon effect persists is that new traders or investors have to learn about it the hard way. That is, they will have to lose money by going along with the herd at least once – they have to learn it by doing it.

Wisdom is unfortunately acquired through painful experience, and not from books, lectures, or even mentorship.

As an anonymous wise person so eloquently put it :”Wisdom is priceless to those who have learned it, but worthless to those who are taught it”.

Which means that, as long as new participants keep joining the financial markets, and more experienced ones refuse to learn from their mistakes, the bandwagon effect will persist.

However, it is very important to note that being cognizant of the market’s herd behavior doesn’t preclude one from trading in the same direction.

After all, markets stampeding in one direction give rise to the strongest trends, which in turn means profitable trades for those prepared to take advantage of it.

But how can we ensure that in doing so we don’t fall victim to the bandwagon effect ourselves?

As with the disposition effect, the best way to guard against falling in with the herd is to construct an effective trading plan and execute it consistently.

In this way, you will always know beforehand when to enter and exit trades, regardless of how manic the hype gets, and/or how strong an influence the bandwagon effect has on you. 

Ultimately, in times of market excess or despair, your trading plan will serve to insulate your actions from your emotions. As long as your plan is sound, well tested, and executed consistently, it will help you keep your trading account healthy.