Cascading Effects on Wall Street

http://news.cnet.com/8301-17938_105-9719952-1.html

The general rule of thumb for stocks is "Buy on rumor, sell on news." Well what if those news were inaccurate and malicious in nature? Well it only takes one post (blogging!) or story to bring down an entire stock due to the domino effect (cascading). People are starved for information especially when it comes to stocks, therefore if one person discovers information (whether truthful or not), then they will act on it. So if that person acts on it, other people will think that person knows something they don't, and will follow their lead. The result is a domino effect of buy-buy-buy or sell-sell-sell based on inaccurate information, that could and most often does, damage the stock and its investors.

It's interesting to think about how in class, it was mentioned that information cascades are fragile, i.e. they can be easily reversed. It doesn't seem that way in this case... if the stock is plummeting, it would seem it would take a significant amount of effort to reverse, as opposed to just a few people deciding to go against the crowd. Then again, I don't know anything about the stock market, so I could very well be wrong.

One way these information cascades stop, Andrew, is when new, conflicting information becomes available. The article mentions at the end that "An Apple representative confirmed that there has been no change in the company's schedule for both Leopard and the iPhone." Apple's stock shortly recovered. Another way that markets balance out "inefficiencies" that are caused by irrational behavior/information cascades is that other, more experienced, investors will buy the stock that everyone wants to sell (at a bargain price). I'm sure that between the initial report and Apple's response, when the stock fell, some investors bought the stock at the lower price and made money when the price increased.

The stock market is different then the information cascades we've seen previously because in examples to this point something becomes popular simply because other people have paid attention to it. However, in the stock market, money is directly involved. Obviously a cascading effect exists because as the initial people sell, the value of the stock decreases which causes more people to sell which decreases the value even further and that continues. It is true that a bit of information can begin these cascades but in my mind they are fundamentally different from the other cascades we've talked about since in makes sense not just socially, but also financially, to follow the crowd in this case.

Yea. I can see how an information cascade is very possible in the case of the stock market but that's one of the risks you take when you invest in it. The market seems so simple (you buy or sell things in hope to gain a profit) but in actuality it's quite complex so when inexperienced people don't know what they are doing and follow their neighbor to invest, they probably aren't making too much money. I remember the stock market game back in the day...my group wanted to buy stock in McDonalds because it was cheap and popular and guaranteed to make money and they were coming out with a new sandwich or something....well yes, that's all fine and dandy and sounds promising but you made like 2 cents a share because everyone knew about it. These cascades could be useful to someone who wants to invest however, if the cascade is contained and only a few people find out...but of course taken to the extreme, that is illegal and we all know what happened to Martha Stewart.

Marissa, information cascades as we discussed them in class are not merely examples of peer pressure that come about by chance. In the example of competing restaurants, it is reasonable to assume that the more crowded restaurant is the better restaurant even though there is a chance that that restaurant just got lucky. The stock market example is actually quite similar to the restaurant scenario. The selling of Apple's stock would translate to the people waiting in line at the restaurant leaving because someone appeared to hate his food (an exaggerated example I know). All of a sudden, it no longer seems that it is worth investing the time to eat at this restaurant (eating out is an investment of time and money). What happened with Apple is that, upon hearing the rumor, people thought the stock wasn't as valuable as they thought it was and sold it (and thought they were saving money), which triggered a cascade.

Marissa Norko wrote:Obviously a cascading effect exists because as the initial people sell, the value of the stock decreases which causes more people to sell which decreases the value even further and that continues.

It is also worth noting that the price, which is the market's estimate of the value, not necessarily the value itself, that plummeted. As I said before, an experienced investor (or someone who has inside information) would have bought up the stock everyone was selling at the lower, bargain price and then made money when the price of the stock later recovered.

I understand that information cascades are not examples of peer pressure but, when I claimed they were socially linked I meant that an information cascade progresses because people assume that others know something that they do not that makes one choice more appealing then another. Therefore, when people see that something is popular, they are more willing to sway from their original opinion. However, the stock market has an aspect of loss. When the stock market cascade begins, investors may think that someone knows something they do not and that would be a reason to sell but an inexperienced investor may also sell the stock because they feel like the stock price will keep getting lower and they are afraid of losing more money then they have already lost. Therefore, they trust the crowd to some extent but they are also preventing possible future losses due to the declining price which is what is not seen in the other examples of information cascades.