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Investing

Herding

25 Jan 2021
By
The next phenomenon worth discussing is known as herding. Evolution has equipped humans with a tendency to herd or stick with the majority. Clearly, this would have served our ancestors well in days gone by, but it can be very treacherous in the world of investing.

Following the crowd has always made people comfortable and being the odd one out leaves most feeling uneasy. We are programmed to think that the consensus view must be correct; however, this mistaken belief that “not everyone can be wrong” has led to many a disastrous investment decision. Following the crowd can cause investors to follow various fashionable investments only because others are doing so.

Bull markets offer excellent examples of herding behaviour, though of course, the same can be seen in bear markets. The dotcom boom of 1999 to 2000 is a perfect example of herding; many investors who were initially sceptical ended up buying into the hype in the mistaken belief that everyone could not be wrong. Yet most people were wrong, and many lost a great deal of money following others into that boom.

The following anecdote is a poignant example of both the human tendency to herd and its inherent dangers. I read it in a book written by Dr Marc Faber, a Swiss investment adviser, also known as Dr Doom for his gloomy view of the markets. In his book, Dr Doom: Riding the Millennial Storm (John Wiley & Sons, Singapore, 1998), he wrote:

“It’s a bitterly cold day. You have lost all feeling in your nose. Your ears are hurting. You hunch your shoulders together to bury your head under the raised lapels of your greatcoat. You turn a corner and you see a frozen pond. Can you risk taking a short cut across? Or would it be safer to walk to the bridge half a mile down the road? You notice a man on the other side of the pond. He gingerly steps on to it. It holds the weight of one foot. He carefully places the other foot on the ice. A young woman behind follows his lead. As you watch, some children arrive with skates, and more adults follow them. Soon, the whole village is having a party on the ice. Each person has given the next person the confidence to join the party. The more people clamber on to the ice, the safer it feels. It’s logical, isn’t it? Or is it? Something makes you stop. You turn around. You walk away. Behind you, you hear the crack and the first scream.”

People’s false confidence following each other into dangerously overpriced shares is a common occurrence during a boom (the same can be said for selling underpriced shares during a bear market). People convince themselves that if everyone else is buying, they can’t all be wrong! But they can all be wrong – and it always leads to a crack and the first scream.

On a final note, I would rather be in the minority anyway and not blindly follow the crowd. Bear in mind that more people fail in the market than succeed, as is the case with many endeavours (sport, for example). Unfortunately, excellence is the exception rather than the rule, and we should aspire to be unique and not merely part of the herd. And remember that the consensus view isn’t necessarily the right view.

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Simon B.

Can you please explain the difference with herding & momentum ?
Thanks,
Simon.

Jordan R.

Hi Simon. Herding is when people buy or sell when others do as it makes them feel safe… it’s all about being a part of the majority, or the herd. Can you give me an example of momentum by any chance? It might help in explaining the difference.
Thanks,
Jordan

Simon B.

Afterpay.

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