What Is Herd Instinct?

The term herd instinct refers to a phenomenon where people join groups and follow the actions of others under the assumption that other individuals have already done their research. Herd instincts are common in all aspects of society, even within the 澳洲幸运5官方开奖结果体彩网:financial sector, where investors follow what they perceive other investors are doing, rather than relying on their own analysis.

In other words, an investor who exhibits herd instinct generally gravitates toward the same or similar investments as others. Herd instinct at scale can create 澳洲幸运5官方开奖结果体彩网:asset bubbles or market crashes via 澳洲幸运5官方开奖结果体彩网:panic buying and 澳洲幸运5官方开奖结果体彩网:panic selling.

Understanding Herd Instinct

A herd instinct is a behavior wherein people tend to react to the actions🎉 of others and follow their lead. This is similar to the way animals 🌌react in groups when they stampede in unison out of the way of danger—perceived or otherwise. Herd instinct or herd behavior is distinguished by a lack of individual decision-making or introspection, causing those involved to think and behave in a similar fashion to everyone else around them.

Human beings are prone to a herd mentality, conforming to the activities and direction of others in multiple ways, from the way we shop to the way we invest. The fear of missing out on a profitable 澳洲幸运5官方开奖结果体彩网:investment idea is often the driving force behind herd instinct, especially in the wake of good news or after an analyst releases a 澳洲幸运5官方开奖结果体彩网:research note. But this can be a mistake.

Herd instinct, also known as herding, has a history of starting large, unfounded market rallies and sell-offs that are often based on a lack of fundamental support to justify either. Herd instinct is a significant driver of asset bubbles (and 澳洲幸运5官方开奖结果体彩网:market crashes) in financial markets. The 澳洲幸运5官方开奖结果体彩网:dotcom bubble of the late 1990꧑s and early 2000s is a 🐭prime example of the ramifications of herd instinct in the growth and subsequent bursting of that industry's bubble.

Because this type of behavior is instinctual, those who don't succumb to it can often feel distressed or fearful. If the crowd is generally going in one direction, an individual may feel they're wrong by going the opposite way. Or they may fear being singled out for not jumping on the bandwagon.

Human Nature to Follow the Crowd

We all cherish our individuality and insist that we take responsibility for our own welfare by making decisions based on our own needs and wants. But it is natural for human beings to want to feel as though they're part of a community of people with shared cultural and socioeconomic norms. So it shouldn't come as a surprise to find that it's just a part of human nature to follow the crowd.

Investors can be induced into following the herd, whether through buying at the top of a market rally or jumping off the ship in a market sell-off. 澳洲幸运5官方开奖结果体彩网:Behavioral finance theory attributes this conduct to the natural human tendency to be swayed by societal influences that trigger the fear of being alone or the fear of missing out.

Another motivating force behind crowd behavior is our tendency to look for leadership in the form of the balance of the crowd's opinion (we think that the majority must be right) or in the form of a few key individuals who seem to be driving the crowd's behavior by virtue of their uncanny ability to predict the future.

In times 🌺of uncertainty, we lo𒊎ok to strong leaders to guide our behavior and provide examples to follow. The seemingly omniscient market guru is but one example of the type of individual who purports to stand as an all-knowing leader of the crowd, but whose façade is the first to crumble when the tides of mania eventually turn. 

Herding and Investment Bubbles

An investment bubble occurs when exuberant market behavior drives a rapid escalation in the price of an asset above and beyond its 澳洲幸运5官方开奖结果体彩网:intrinsic value. The bubble continues to inflate until the asset price reaches a level beyond fundamental and economical rationality.

At this stage in a bubble’s existence, further increases in the cost of the asset often are contingent purely on investors continuing to buy in at the highest price. When investors are no longer willing to buy at that price level, the bubble begins to collapse. In 澳洲幸运5官方开奖结果体彩网:speculative markets, the burst can incite far-reaching corollary effects.

Some bubbles occur organically, driven by investors who are overcome with optimism about a security’s price increase and a fear of being left behind as others realize significant gains. Speculators are drawn to invest, and thus cause the security price and trading volume to climb even higher.

The 澳洲幸运5官方开奖结果体彩网:irrational exuberance over dotcom stocks in the late 1990s was driven by cheap money, easy capital, market overconfidence, and over-speculation. It did not matter to investors that many dotcoms were generating no revenue, much less any profits. The herding instincts of investors made them anxious to pursue the next 澳洲幸运5官方开奖结果体彩网:initial public offering (IPO) while completely overlooking the traditional fundamentals of investing. Just as the market peaked, 澳洲幸运5官方开奖结果体彩网:investment capital began to dry up, which led to the bursting of the bubble and steep investment losses.

How to Avoid Herd Instinct

Herding may be instinctual but there are ways for you to avoid following the crowd, especially if you think you'll be making a mistake by doing so. It requires some discipline and a few considerations. Try following some of these suggestions:

• Stop looking at others to do the research and take the steps to study the facts for yourself
• Do your due diligence and then develop your own opinions and your final decision
• Ask questions about how and why people are taking certain actions and make your own decisions
• Delay making decisions if you are distracted, whether that's because of stress or any other external factor
• Take the initiative, be daring, and don't be afraid to stand out from the crowd

Herd Mentality FAQs

What Are Some Potential Dan♓gers of Herd Mentality in Markets?

Herding or following the crowd can cause trends to amplify well-beyond 澳洲幸运5官方开奖结果体彩网:fundamentals. As people pile into investments for fear of missing out, or because they have heard something positive but have not actually done their own 澳洲幸运5官方开奖结果体彩网:due diligence, prices can skyroc🅺ket. This irrational exuberance can lead to unstable asset bubbles that ultimately pop.

In reverse, sell-offs can turn into ꦑmarket cra▨shes as people pile in to sell for no other reason than others are doing so, which can turn into panic selling.

What Are Some Positives of Herd Mentality in Mar🐓kets?

Herding behavior can have some benefits. It allows novice or uninformed investors to benefit from the due diligence and research of others. Passive 澳洲幸运5官方开奖结果体彩网:index investing, for instance, is a herding-type strategy that relies on simplܫy matching the broade🌊r market's performance.

Herd instinct can also let the novice trader cut their losses early since it is often better to sell along with the crowd than risk being a 澳洲幸运5官方开奖结果体彩网:bag holder.

Outside of Investments, What Are Some Ot꧒𝔍her Examples of Herd Mentality?

Herd instinct appears in several contexts and throughout human history. Aside from various asset bubbles and manias, herding can help explain mob behavior or riots, fads, conspiracy theories, mass delusions, political and social movements, sports fandom, and many others. For instance, people may rus⭕h out to buy the newest smartphone because of its popularity with other consumers.

How Can One Avo𒁃id Falling Victim to Herd Mentality?

A good way to avoid this is to make investment decisions that are based on sound, objective criteria and not let emotions take over. Another way is to adopt a 澳洲幸运5官方开奖结果体彩网:contrarian strategy, whereby you buy when others are panicking, picking up assets while they are on sale, and selling when euphoria leads to bubbles.

At the end of the day, it is human nature to be part of a crowd, and so it can be difficult to resist the urge to deviate from your plan. Passive investments and 澳洲幸运5官方开奖结果体彩网:robo-advisors provide good ways to keep your han♐ds off of y🍒our investments.