Herd Mentality: You Are Being Set Up to Fail

Think back to a moment when you were younger, a teenager perhaps, and there was something you wanted to do because it was suddenly cool and it seemed like everyone you know—and many people you didn’t—were doing it. Just as you’re about to dive into whatever the fad of the season is, someone (a parent, teacher, observant adult) stops you and tells you no. “But everybody’s doing it!” You whine. “And if everyone jumped off a bridge, would you do it too?” If this exchange is familiar to you, then you already know something about herd mentality.

It’s the tendency that people have to mimic or emulate the actions of other people in a large group. Unfortunately for all of us, we don’t always choose to imitate the rational behaviors of others. Sometimes, herd mentality stems from copying the actions of people of high status, but often, herd behavior is the result of going with the crowd.

Herd Mentality Psychology

There are two main explanations for herd mentality. The first is social pressure, also known as the dreaded peer pressure! Humans are social creatures and want to be accepted by the group, not excluded for being an outcast. Thus, we often choose to follow what everyone else is doing as a means of acceptance. Remember, herd behavior is not generally the result of a conscious choice. Even iconoclasts, hermits, and introverts are subject to social pressures beyond their control.

The second explanation for herd mentality is the “How could so many people be wrong?” rhetorical question that advertisements are so fond of. Popular logic dictates that if so many people are doing something, it must be the right thing to do. Surely, not all of those people would be wrong? In fact, everyone could be wrong. It’s a little scary to think about, but there are plenty of situation in which no one really knows what he or she is doing. The caveat to this sort of thinking is that individuals with more experience are less likely to fall prey to it; it’s the people with very little experience in a field who are most likely to exhibit herd behavior on the basis of “everybody’s doing it.”

Herd Mentality in Stock Market

We see lots of examples of herd mentality in investing and financial decisions, due in no small part to the fact that many people don’t really understand what they are doing when it comes to the markets. Let’s start with a classic example of herd mentality: tulip mania. In the late 16th century, the Dutch tulip market was booming. Tulips were a novelty for most of the world and were one of Holland’s major exports. They were so popular that men were making and losing fortunes in one night. In fact, tulips were selling at as much as ten times the price of the work from skilled craftsmen. The price of tulips skyrocketed thanks to trading in tulip futures. When the bubble (widely considered to be the first such financial bubble) finally burst in 1637, fortunes were lost. Why would people go crazy for tulips? The simple answer is herd mentality.

From our perspective almost 400 years later, trading on tulip futures seems ridiculous. Why would anyone do that? However, we should not throw stones. Two modern bubbles were almost as ridiculous: the Dotcom bubble at the tail end of the 20th century and the subprime mortgage crisis of 2008. Modern investment decisions are fueled at least as much by emotion as logic, if not more so. We observe our peers funneling cash into apparently sound investments—investments that are sure to go up and make us rich! When that happens, most people follow suit. Few individuals take the time and effort to do the research, but rather are swept up in the rising tide of enthusiasm and hype.

Herd mentality does result in bubbles, but it can just as often result in missing out on something amazing. One company that no one wanted to buy in at first is Apple. Apple’s share prices opened on the NYSE in September of 1984 at $26.50. And now? Apple is currently trading at over $440 per share. Plenty of people in 1984 thought that personal computers would not go anywhere, thanks to herd mentality. Unfortunately for them, they were wrong.

As ever, when it comes to investing, you have to do the research and follow the path of logic and facts, not the way of media hype and enthusiasm from all quarters. If you can learn to use the conscious part of your brain for investment decisions, you can pick up stocks that others might be overlooking— and sell before the next bubble pops.

After all, the greater fool might refuse to show up

What do you think? Have you fallen prey to the group think? How did it affect your results? Let us know with your comments below

Angie Picardo is a staff writer for NerdWallet. Her mission is to help investors stay financially savvy and save money with NerdWallet’s best rates on money market accounts.

Comments

  1. AuntiOccupy says

    TODAY IN AMERICA YOU RISK YOUR LIFE IF YOU REFUSE TO GO WITH THE CROWD

    Refusing to do or to oppose what is wrong can turn friends and employers against you.  You can be labeled extremist, insane, Bible Thumper, radical, etc.  Wanting to do the right thing today is dangerous.

  2. says

    I agree. And I have to say the pressure to follow is tremendous. Having studied marketing for many years for my customers benefit, I am amazed when I watch myself fall into these traps. Just when I think I have learned my lesson, I find myself wanting to do what I see others doing. Thanks for the reminder that we have this all to human tendency. BTW, I just pulled out of the stocks and I never did buy gold. Maybe I am getting better! lol! Maria Bailey- Success City Online.

    • says

      @Maria Bailey Maria, good call on not buying gold! Generally if you do what everyone else does, you will get the same results as what everyone else gets – in other words, average. People get scared that by forging their own path they might be setting themselves up for failure, but that is the wrong attitude to go through life with. Never ventured, never gained.

      • whateverdude005 says

        ShaileshKumar Are both of you idiots?  you sound exactly like the heard.  You didn’t buy gold and you’re glad?  What?  Oh, you mean you didn’t buy gold last week when it was the heard thing to do.   I bet when people were buying back in 2003 you were just like the heard saying that gold and silver was antiquated.  So, no, you’re not getting better in the big picture, you’re just better in your current state of mind.  Grow some balls and take a stance and then stick to it.  Make decisions without reading WSJ, IB, or Yahoo first.  That’s going against the heard.

        • says

          whateverdude005 I have no reason to take a stance that YOU agree with. This “idiot” does very well on his investments without pandering to the crowd. You should explore the site a little more to understand this.
          Normally I do not approve comments that are disrespectful. In this case I will let it stand for its instructional value.

  3. investing guy says

    I’m wondering why you haven’t mentioned the bitcoin “bubble” if that’s what you can call it. I’ve been watching bitcoin, not buying in for awhile now. It seems that bitcoin is slowly rising in price again, and could be a worthy investment, or could not be. It however was not intended to be an investment that you could make returns on. it was designed to be a currency that is anonymous, decentralized, and secure. I’m just wondering why this would happen and if there are any other currencies that has been done with?

    • says

      @investing guy This one is hard. As far as I understand, bitcoins are not tied to the economy in any way. Currencies in general are ultimately tied to the GDP, productivity and the financial management of the country (interest rates, money supply, etc). It is then hard to make any kind of value judgement on the worth of the currency.

      In the hind sight, bitcoins may very well turn out to be another chapter in the book “Extraordinary Popular Delusions and the Madness of Crowds” by Charles Mackay, whenever the book is updated.
      To me, it ranks right up there with the Dutch tulips.

      • brooksgracie says

        Don’t be so smug on bitcoin.  In reality, it is a substitute for actual money for services performed.  A quantifiable substitute for cash payments for services.  The IRS is scared to death of it, because it bypasses tax reporting requirements.  Its weakness is “what happens when I order a service and have a negative bitcoin balance?  Do I have to actually pay someone?  I don’t think there is a contractual enforcement mechanism.

      • says

        brooksgracie All that is true but the question is whether it will get widespread acceptance and stand the test of time. I had similar misgivings about Paypal when it started, it was also quite revolutionary in its time. Now Paypal is everywhere. So you are right and I might turn out to be wrong on this one.
        On the other hand, these kinds of revolutions come and go and for every 1 success, there are 100s of failures. The network effect of the current users may very well push it to the mainstream and that remains to be seen.
        As for bitcoins being a possible investment, I might be missing the boat, but I can not make any kind of reasonable valuation or investment thesis. I am generally fine missing out on a new trend as long as I can avoid the risks

  4. VanFenix says

    I buy in, I don’t care what people do – I buy in a company because I choose to.  I won’t sell in despair.  useless!

  5. SteelHawthorne says

    Gold is a stange asset/commoditity that is as old as man it seems.  What is the current take on silver?  It seems to have a foot in several categories(commodity,bling,industrial) and is intriguing to me.   Mostly because my grandfater hoarded a bunch throughout his lifetime and left it to me.   My relatives did not really care because silver was 4 bucks an ounce when he passed.    I sold some at $39 and bought some at $28.  I really feel it’s headed for $12.  I would like to buy more then but part of my reasoning is to simply add to the collection that I intend to give to my kids.  How should we view silver?

    • says

      SteelHawthorne As long as you are not speculating it is probably a good buy at $12. It takes 24 years for $4 to compound to $39 at 10% annual return (long term equities returns), to give you a perspective on the opportunity cost of holding silver which is probably similar to the return you achieved when you sold at $39 (I am guessing here though :-)).

      These are very much cyclical commodities so there is an opportunity to profit but it may require a long wait. Seems like you are thinking really long term multi-generational holding in which case it would be okay. Just teach your kids to be opportunistic but not speculative :-)

  6. brooksgracie says

    I never followed herd mentality, but it sure has hurt me anyway.   I found out the hard way that irrationality on a mass scale can outlast my ability to fight irrational herd mentality.  For example, in 1999-2001 I consistently bought puts on Cisco, knowing for sure as a CPA and attorney with a bunch of clients who were in the internet provider circle realized that Cisco had a value based on a growth rate that was unobtainable in itself, not to mention that there were better products available from new companies such as Juniper and Redback.  Well, the long and short of it was that I got killed, not because I was wrong (Cisco’s stock price eventually cratered), but because the irrationality of investors outlasted the money I had to invest.  I simply figured it out too early and traded on it.   Had I simply waited 2 years to buy the puts, I could have retired by now.  But it took entirely too long for other investors to realize that the emperor had no clothes.
    The biggest obstacle is Wall Street’s offerings.  Go ahead and look for a call option on oil for example that doesn’t expire for 20 years.  They are afraid to sell them, yet you can buy any investment that should increase in value and hold it for as long as you want (except of course call options).   The experience also cleansed me of trying to time the market, which precludes buying options of any kind.  Bottom line–no matter how much research you conduct, or how right your conclusions ultimately are, you are still a slave to the herd mentality, since it is impossible to know when it will pivot in either direction,,

    • says

      brooksgracie Yes, markets can remain irrational longer than you or me can remain solvent. The only way out I have found is to go where the herd doesn’t. More often than not, this turns out to be beaten down small company stocks that are not followed much by the wall street.
      It is quite interesting you mention Cisco. I did get caught up in some of the internet names during that time and came out okay but never could bring myself to share the enthusiasm about Cisco Systems. I recall at that time it was being mentioned as potentially the first trillion dollar company and whenever that happens, you can be sure that the stock is topping out. This has played out with Cisco, Microsoft and now Apple.
      As much as possible, I try to avoid making value judgements based on expectation of future growth. Whenever we do this, we are discounting the fact that in any profitable sector, competition is bound to appear and get stronger. Close to 100% of the growth estimates are wrong.

  7. says

    brooksgracie Yes, markets can remain irrational longer than you or me can remain solvent. The only way out I have found is to go where the herd doesn’t. More often than not, this turns out to be beaten down small company stocks that are not followed much by the wall street.
    It is quite interesting you mention Cisco. I did get caught up in some of the internet names during that time and came out okay but never could bring myself to share the enthusiasm about Cisco Systems. I recall at that time it was being mentioned as potentially the first trillion dollar company and whenever that happens, you can be sure that the stock is topping out. This has played out with Cisco, Microsoft and now Apple.
    As much as possible, I try to avoid making value judgements based on expectation of future growth. Whenever we do this, we are discounting the fact that in any profitable sector, competition is bound to appear and get stronger. Close to 100% of the growth estimates are wrong.

  8. isa case says

    well………..rational decisions are always best……however….try as one might…..rational thinking is dependent on information received………..and its trustworthiness…….and often on other circumstances and knowledges such as ……..if something will or will not be approved by the government…………so the problem…..which creates the fear of rational individual thinking about  investing is: there are aspects that our out of your control…..such as a.an information gap between that which is…and the information you are priv’vy to…..thus it can be assume that more individual rational investing might take place…if information were available to all instead of insiders being able to trade on knowledge that has been denied others….b..intentional pitfalls (such as rumors) and rigging might be taking place that those outside the loop are not aware of..
    In addition, if we had a market place that could be trusted to invest in good business and its goals were to support a healthy economy..instead of a Casino one that encourages those that play to have a gambling kiss the dice mentality….we might see another kind individual investor emerge.
    Therefore, while I do not deny the herd mentality (some of the time for all, most of the time for some and all of the time for many and is not just a Main Street characteristic (as one can easily detect by just reading the newspapers)…… I would say we could draw more accurate assumptions about the herd mentality and rational investing if everyone had trusted access to the all the information.

    • says

      isa case True, but wouldn’t you say this is also an argument for investors to do their own diligence and make independent decisions? 
      When information asymmetry exists, it makes even less sense to trust your life savings to a fund manager. Doing that you are assuming they are privy to better information than you, in most cases they are not. Add this to the fact that they are more worried about growing their assets under management, and less about generating absolute returns, and you have a lop sided market.
      It is vitally important to know where your information and advice is coming from.

  9. isa case says

    brooksgracie and here is the rub:  you were an attorney and a CPA and had clients who knew the industry you were buying puts on……….and you were hurt anyway…..but if you had gained…think of the herd……they may have been buying not just based herd mentality and stupidity  but on the best information allowed to the supposed herd.  And so even if you had been lucky…………others might have been unlucky not necessarily because they were less capable investors then you were…………
    So….perhaps the goal in a healthy economy would be…..to separate the casino so called investing from investing in products that support a healthy growing economy instead of winner- loser mentality.  One does not have to play against others to take their hard earned money…one can play to support an economy of growth……and development that would actually benefit the common good.

  10. Red Dragon Hawk says

    this story makes me feel successful , in that i have never really been able to afford the herd mentality. 
    the knowledge of my finances and understanding of want vs.need

  11. Fred Botz says

    ‘Investing’ with fiat currency and expecting ANY return itself is herd mentality. Wall Street is nothing more than an elaborate game of Three Card Monty.

    • Red Dragon Hawk says

      Fred Botz my advice to anyone is invest in what you need,invest in what your children will need

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