Investors’ Behavioral Biases: Part V – Herding
Humans are hard-wired to belong to a group, typically one with shared cultural and/or socioeconomic attributes. Most people are social and have a natural desire to be accepted by the group, and therefore adopt the group’s customs and behaviors. An individual may behave quite differently when away from the group.
Many species run in herds as protection from predators, similarly for humans in the past. Today a form of herding can be seen at sports events, concerts and the like.
Herding is very common in the investment space. A good example is the way institutional investors often make the same investment choices, as do many hedge funds. Because it is reassuring to see numerous investors doing the same thing as you. And of course there is safety in numbers, particularly should the investment fail.
Herding is a primary cause of market bubbles. An example of herding leading to a bubble is the Australian junior lithium space. Elon Musk is going to have us all driving coal-burning cars that will require large quantities of lithium. So any ASX announcement mentioning lithium (read more here) causes a buying frenzy. Quite unrelated to any underlying value. Similar to the dot-com bubble, Australia’s real estate bubble and so on.
Steer clear of the herd. Do you own research and make a decision based upon the results of that research. In the case of the lithium sector, there are certainly some companies of interest, but many more that will ultimately cause tears.
Herding is a behavioral biases that is quite easy to avoid. But beware of the fear of missing out (“FOMO”). Don’t jump on board just because everyone else is doing it.
Image Courtesy Prime Capital