Often in financial markets, as in our daily life, we imitate the decisions of predecessors, instead of analysing available information and making our own decisions. This decision imitation could lead to collective hysteria, and investment calls may be influenced by these panicked situations.
Imagine that you’re looking for a place to have dinner, and find a street with two restaurants. Both look good, but they’re empty because it’s still early. You decide on a whim to enter restaurant A. The moment you’re seated, a couple arrives – also intending to have dinner. Since restaurant A already has a customer (you), they decide to go for that one.
After all, since it has a customer, that one ought to be better, right? Anyone else who comes along looking for dinner will likely also reach the same conclusion. As a result, restaurant A will be full, while B will remain empty, although in principle either is equally good.
This is an everyday situation. How many of us go to a certain dentist, hairdresser or handyman because we’ve been recommended to do so by a friend who’s already used their services, even though there are others who look just as good? Personal information may be useful, but sometimes we’re more influenced by others.
The same thing happens in financial markets. Each investor receives information (signals) about how they should act. They also know the decisions of their predecessors, although they don’t know the signs they received. Using this knowledge, each investor makes their own decision. But this ignorance of previous signals can sometimes cause investors to ignore the signals they receive in the here and now, and instead adopt the same decisions as