“bandwagon” theory

Traders often hear about “tulip mania,” the “South Sea bubble” and other similar events where traders have followed the crowd to send prices to extreme levels. You might add the technology dot.com bubble of the late 1990s or the more recent housing bubble to the list of those events where traders got carried away with higher and higher prices. Everyone wanted to be part of the action – the “crowd psychology” or “bandwagon” theory. The same type of crowd response applies to price action on a smaller scale, too. For example, when a market is coming up from a basing area on the charts, “smart money” is responsible for the majority of the initial buying. As people jump on board, we see the bandwagon effect, and that bandwagon pushes prices up. Volume tends to surge at its peak, certainly on the buy side, during the markup phase in the middle. Later, toward the end of the trend, smart money is not doing the buying; somebody else is. The smart money is doing the selling. The market tops by rolling over or sometimes with a spike top. We can see the crowd impact expressed in price and in volume. Just think about what happens among professional traders when the stock market goes up even when the fundamentals don’t provide much support for such a move. Prices often rise because institutional money managers feel pressured to follow the crowd and chase performance. How can they explain why their results are below the industry benchmarks if they don’t go with the crowd and buy the stocks everyone else has in their portfolios? That rationale alone can drive markets higher than they “should” go.