Following The Herd

In the world of investment, investors are very much prone to herding. Following the herd or herd mentality is when people get influenced by other investors for buying assets without using their analysis. Blindly following the crowd in investments can be risky and cause damage to your Portfolio.

Following the herd is common in social life as well as financially. Investors perceive what other investors are doing and believe their assumptions rather than relying on their own analysis. Herd following creates panic buying or selling, Market crashes and also asset bubbles.

The term ‘herd mentality' is part of behavioural finance theory, where investors are largely influenced by emotions and instinct, rather than self-analysis. Such behaviour by the investors creates market Volatility because the market sees a series of over and under reactions spread in that time phrase.

Herd investors buy and sell their investments in pursuit of the newest and hottest market trends. For instance, if a herd investor hears that tech stocks are the best to invest now, they would free up Capital from their portfolio to invest there. Likewise, if they hear pharma stocks will boost in the next three months, they will probably move their capital again.

What Causes Herd Behaviour?

There could be many reasons for an investor to follow the herd. The most obvious is the lack of information. At times, even information about market trends and companies distributed are asymmetrical. In such a scenario, investors, especially newbies think that if a group of investors are Investing in a stock, that would be the right trend to follow. Commonly, it is uninformed investors, who try to get rich quickly by successful traders.

Sometimes, investors try to time the market, which results in following the herd. Also, Peer to Peer pressure is one of the prime reasons for herd mentality.

How not to Follow the Herd!

A straightforward way is to make rational decisions by doing your own self-study. Successful investors never follow the herd, in fact, they become successful by exploiting the gaps created as a result of herd mentality. Therefore, say a big no to emotional decisions. Keep distance from the crowd as it helps to make rational decisions.

Give time for research and take the steps based on facts. Even if you see investors following the herd, ask yourself why people are doing this, and then do your own analysis. Another way is to adopt a contrarian strategy, wherein you buy assets when others are panicking, and sell in the bull market. It is trading against prevailing market sentiments.

Lastly, have your own opinion for final investment decisions.

Conclusion

Following the herd can be both efficient and inefficient. Sometimes, the decisions of others can benefit uninformed investors. Such instances encourage newbies to follow herding.