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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.
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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.”
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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
Not convinced that you may fall into the herding behavior in your investments? This will be easy to test with a stock market game online. If you find yourself susceptible to this tendency, you can always step back and make a note of the triggers and work to correct these without risking much of your hard earned capital.
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.