Herd mentality in the market

For thousands of years, it has been safest for humans to stay together in a herd. Wandering alone on the savanna was deadly. This biological urge to do as everyone else does is deeply rooted in us, and it becomes very visible when we log into the stock market.

"Let go of human fear, and let divine intuition lead you."

— Florence Scovel Shinn

Herd mentality occurs when people stop thinking for themselves (using their intuition), and instead just copy what the masses are doing. If everyone suddenly buys shares in a new hydrogen company because it is on the front page of every newspaper, it feels safe to do the same. It cannot be wrong, right?

Bubbles and crashes

The answer is unfortunately often yes. This is exactly how financial bubbles occur. The herd drives prices up to absurd levels completely disconnected from reality. And when the bubble finally bursts, the herd turns in mortal fear. Everyone runs for the exit at the same time to sell, creating a gigantic stock market crash.

Go against the current: Many of the most successful investors call themselves contrarian. They deliberately do the opposite of the herd. They buy when there is panic and everyone else is selling, and they sell for a good profit when everyone else is greedy and wants to buy.

Is it always wrong to follow the herd?

Disadvantages (Following the herd)

You often buy at the top (when the hype is highest) and sell at the bottom (when panic spreads).
You lose the ability to critically analyze companies yourself.

Advantages (Momentum)

In the short term, it can be very profitable to ride the wave the herd creates, as long as you remember to jump off before the music stops (momentum investing).

Herd mentality in the market

Bubbles and crashes

Is it always wrong to follow the herd?

Disadvantages (Following the herd)

Advantages (Momentum)

Ready to try it in practice?

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