Have you ever witnessed a stock blast higher on heavy, I mean heavy volume—on its ascent to the day’s highs…
Some traders will get irritated, and start asking questions like: I need to get in this trade, but is it too late? Wouldn’t this be considered chasing?
For many, the fear of missing out (FOMO) gets the best of the trader—forcing them to dive into a trade that they probably have no business in, with no plan or strategy to win.
I don’t have to finish this story… because I’m sure you know how it ends.
And you know what?
This happens EVERY day in the stock market. And for some traders, following the herd has a crippling effect on your performance.
We all know that many of the top traders are contrarians. They think differently and trade with conviction—not waiting around from confirmation from the crowd or anyone else for that matter.
How do you snap out from having a herd mentality?
And how much money are you leaving on the table from this one avoidable mistake?
Herd mentality describes how people can be influenced by their peers to adopt certain behaviors on a primarily emotional rather than rational basis.
Since the market is a giant living organism of human behavior, trying to predict what the market will do in two weeks, much less two months from now is impossible.
Much like the markets, this phenomenon is also found throughout nature, as well.
More well-known as a murmuration, where thousands of birds change direction almost simultaneously, shape-shifting to avoid a predator, like a shark or a hawk, as if it was a single swirling mass.
Where Did It Come From
In some limited cases, herd mentality might be a good thing. Think of the lone caveman trying to avoid predators.
In his case – staying together in a large herd while in the jungles is probably smart to avoid being eaten from a larger animal.
Just like evolution occurs in certain species that change to their environments, this behavior has also evolved over 1000s of years from previous civilizations.
“The opposite of courage is not cowardice, and it is conformity. Even a dead fish can go with the flow.” – Jim Hightower
Rule of thumb: If it feels right, it’s probably wrong.
Instead—do your research and don’t simply follow the markets because its “the cool thing to do.” Doing the same as everyone else is a risky proposition.
Most Popular Case Of Herd Mentality
In case you forgot, most of us here have lived through one of the worst examples of herd mentality in market history.
I’m not talking about the Tulip Bubble folk, but instead the Dot Com era of the late 1990s and early 2000s.
I am sure you can talk to anyone in your family, and they will give you an example of being burnt by stock in this period.
Heck, my neighbor gained millions and lost even more, when the collapse occurred, and I didn’t have to go near Wall Street to find an example of this issue.
Since tech companies were booming and people were hearing stories of friends making millions on this hot stock doubling in price every day,
With many retail investors were feeling left out (FOMO), they began investing in companies with little to no understanding of their business model to have a piece of the action.
Unfortunately, as we all know today, those that jumped on the bandwagon quickly found out the hard way what happens when the bubble burst.
They were just sheep in a herd and were taken out to pasture and slaughtered.
There are many cases like this across the world markets, and one of the reasons why every bubble is an example of herd mentality gone wrong.
Biggest Issues With The Herd
There is a famous quote by one of the world’s wealthiest investors, Baron Rothschild, that sum up the issues with the herd mentality.
“It’s time to buy when there’s blood in the streets.”
– Baron Rothschild
Many times when markets are in a downward trend and investors are feeling saddened by a decrease in their assets, many start to panic.
Fueled by the media and the shrinking capital in their investment accounts, the nervousness grows and grows. With each passing day, your stocks continue to trend lower.
Afraid of the news, you notice the herd begins to shift away from your stock and exit the trade. Their selling pressure adds to more losses as the stock continues lower.
Eventually, you crack, and you sell your stock to watch it rally back up to the price level it came from. All while you watched from the sidelines.
This is probably a typical story with many investors. Unfortunately, instead of selling, a wise and rational investor would have bought more stock to dollar-cost average his price lower.
In this case, you were following the herd, and you exited the trade for a loss.
How To Save Yourself From Herd Mentality
These stories are examples where rational decisions always make for better trading over spontaneous or irrational behaviors.
It’s important to remember that assets should always be bought and sold as a planned investment strategy instead of based on emotions.
Here are some tips for avoiding the Herd Mentality:
- Create a trading plan and stick to it day in and day out
- Research all investments you make
- You should be ready to face some ups and downs in the market.
- It is impossible to time the market correctly and buy at the lowest prices and sell at the highest prices.
- You should not get emotionally attached to the profits and losses made.
- You might still face losses or miss some opportunities, but you should focus on your goals.
- No one can get the best of the market every time.
When the bell rings on Monday, make sure you have your trade plan in place and you stick to it. The temptation of following the crowd on some hot stock that’s flying will always be there, learn to let those thoughts pass.