How Many Fools Does It Take

By Jason Zweig via http://online.wsj.com   Article

How Many Fools Does It Take to Make a Bubble?

“Where do market ‘bubbles’ come from? A team of neuroscientists and economists has produced the first scientific evidence for what prudent investors have long believed: Paying attention to what others are doing is the easiest way for traders to get carried away.

… bubbles might be caused not by traders who lack information but by those who have too much. … traders pay more attention to what others are doing in the midst of a bubble than they do in placid markets.

Furthermore, those with the worst tendency to ‘ride the bubble’—buying more enthusiastically as prices soared away from fundamental value—paid particularly close attention to other traders’ actions. …

‘If everybody else is doing something silly, maybe you should detach the network and social links that make you susceptible’ … ‘You could live in Omaha instead of New York’ … an allusion to Warren Buffett’s deliberate detachment from the daily hubbub of trading. …

You also can use a checklist with rules like these: Never buy a stock or other asset purely because its price has been going up or sell just because it has been going down.

Before you buy, list several reasons—other than price—that make it a good investment. After any big up or down move, review those reasons and ask whether the new price has invalidated them.

In short, the best way to avoid a bubble is to think for yourself.”

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