Herd Behaviour

“Men, it has been well said, think in herds”, Charles Mackay once said.

Herd behaviour is common in the stock markets. In the stock market, herding behavior is irrational and is driven by emotion—greed in the bubbles, fear in the crashes. Individual investors join the crowd of others in a rush to get in or out of the market. When the market is rising, people who are not invested are driven by greed and want to enter the market to make money as well. When the market is falling, people flee out of the stock market, out of fear. This is a perfect example of herd behaviour.

A famous experiment by Muzafer Sherif conducted in 1937 shows the herd behaviour succinctly. A group of people was asked to sit in a darkened room and observe a point of light through a small hole. They were told that the light would move and asked to estimate the extent of the movement. In actual fact, the light did not move at all, but when the subjects were later placed in discussion grounds, all agreed that movement had occurred and discussed only by how much they moved. When subsequently questioned, none appeared to be aware of any group influence.

The proper way to invest is to be fearful when others are greedy and be greedy when others are fearful. Buy during a market crash and sell at the peak of the euphoria and you won’t go wrong. Yes, it’s difficult to sell at the peak but we can always sell around the peak when we sense the euphoria and when the P/E ratios are shooting through the roof.

Advertisements

11 thoughts on “Herd Behaviour

  1. Hi WB,

    Yes, if it was, everyone would just apply a formula and make money applying that formula in the market. It’s part science part art.

    Anyway I have always been wanting to ask you what does “WealthBuch” mean?

  2. I will let it go since the valuation is too high (P/E at 32) and Peter Lim already holds 60% of TMC now. I have a strong feeling he will buy 100% of it and delist TMC. So, no point holding on to a private company as it will be harder to keep up with the company and sell my stake later.

  3. HI financialfreenow,

    We all know:-

    People herd because of fear.
    People herd because of greed.
    People herd also because they just follow.
    People just – follower when they are “slaughtered” in a Bear Market, still don’t know why or how they are “slaughtered”.

    But will people herd because of “common-sense” to buy when there is a “fire-sale” in a crashed market?
    Will people herd because of courage to buy in a Bear market?

    And for every herd , there must be started by a leader.
    The leader will never be you or me or he or she.
    The leader till now is almost always someone belong to America, because America’s GDP still equal to about “BRIC” combined GDP.

    Oh yes investment in stock markets is never an “exact science” because it is people who make the market and not science. And God makes every person unique. Anyway if science make the markets, the scientists will finally kill all the markets.

    • Hi telstar,

      Thanks for visiting my blog.

      You asked “will people herd because of “common-sense” to buy when there is a “fire-sale” in a crashed market?”. I don’t think so as they are all fearful and busy selling like you said “people herd because of fear”. You also asked “Will people herd because of courage to buy in a Bear market?”. I don’t think so too as they are all still fearful. They only come together and herd once they collectively feel the market has stopped plunging and is set to go up. For this catalyst to occur, usually a major positive news is needed by the press/TV.

  4. Hi financiallyfreenow,

    People herd because of fear.
    And I always wonder so many fear-panic sellers at one go,
    how come opposite side of this herd, there is a buying herd?
    Or a only a few big time market operators; Oops! I mean market manipulators?

    Regards.

  5. Hi telstar,

    You said you always wonder that if there’s so many panic sellers at one go, how come there are buyers at the opposite side of this herd.

    There are many ways to explain this because if you are someone who cultivate strict trading or investing rules, you would have your reason to do so.

    To an investor, he could be buying as the price is way below his intrinsic value.
    To a break out trader, he could be buying as he’s predicting the tide might be turning.
    To a director of a company, he could probably just act like Buffett who like to increase the cut-size of the pie.

    However, to someone who just buy without any strong reasonings, I could only say he’s the greater fool.

  6. Hi cj, financialfreenow,

    I believe in strict investment rules.

    But I like to believe also in times like that, there are many “investment sharks”.

    In fact, I like to think the fear- panic-selling herd is started by these sharks when there is an opportunity for them to do so.

    I had discussed this with a veteran remisier/broker and he agreed “anything” can happen in the market.

    On the other hand without these sharks around, the market will be very “dull”. There will not be a “firesale”

    And we may not have an opportunity to buy in a “firesale” market.

    We should in a way “thanks to them and no thanks to them”.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s