Cognitive Bias – Herding Behaviour
“Always drink upstream from the herd.” – Will Rogers
Herding behaviour, in the stock market, refers to the tendency of investors to follow the actions and decisions of others rather than making independent investment choices. It is a psychological phenomenon where individuals are influenced by the actions of a larger group, often driven by a Fear Of Missing Out (FOMO) or a desire to conform to social norms.
Here are five key points to consider:
- Emotional contagion:
Herding behaviour can be driven by emotional contagion, where investors are influenced by the emotions of others. For example, if a group of investors panic and start selling their stocks, others may follow suit out of fear of losing out, even if they do not have a rational basis for selling.
- Information cascade:
Herding behaviour can also be triggered by information cascades, where investors follow the actions of others because they assume that those actions are based on superior information. This can result in a self-reinforcing cycle where investors keep copying each other without fully evaluating the underlying information.
- Risk of irrational decisions:
Herding behaviour can lead to irrational investment decisions. When investors follow the crowd without conducting their own research, they may end up making poor investment choices or missing out on opportunities that they would have otherwise identified through independent analysis.
- Market inefficiencies:
Herding behaviour can contribute to market inefficiencies. If a large number of investors are all buying or selling the same stocks based on herd mentality, it can distort market prices and lead to mispricings. This can create opportunities for informed investors to exploit these mispricings and make profits.
- Long-term risks:
Herding behaviour can pose risks to individual investors and the overall market in the long term. If too many investors are herding in a particular direction, it can create a bubble that eventually bursts, leading to severe market downturns. Additionally, herding behaviour can prevent investors from diversifying their portfolios and managing risk effectively.
Managing Herding Behaviour:
In conclusion, herding behaviour in stock market investing can lead to irrational decision-making, contribute to market inefficiencies, and pose risks in the long term. As an investor, it is important to be aware of the influence of herding behaviour and make independent, well-informed investment decisions based on sound research and analysis rather than blindly following the crowd. Attending Wealthwise Education’s ‘Invest for Success’ Program will teach you that diversification and risk management should be taken into consideration to mitigate the potential negative impacts of herding behaviour.
Stock Market Investor Education:
‘Invest for Success’ – is a 4 week program starting with a 2 day in-person workshop + 4 x 1 hour online sessions over 4 weeks. Call us now for more information +61.2.9488.9900.
Read more: Top 5 Cognitive Biases Overview