What is the herd effect?
We speak of a herd effect when a multitude of people make similar choices more because of an emulation effect than anything else.
Theemulation effect is part of man. It is in his nature. If you think about it, we learn and know the world from birth by “copying” others. The behaviors of our parents, relatives and friends “introduce” us to society and we often reproduce them in our lives, even without realizing it, perhaps reshaping and calibrating them to our character or the situations we face.
But what is this herd effect in trading?
It is clearly difficult to go against the current because, as we have said, emulating others is a natural instinct. In the financial sphere, however, it can pose a serious danger. Behavioral finance tells us that the herd effect is one of the most insidious and most frequent mental traps for traders.
Investing in a stock or other financial instruments just because of hearsay or because many people do, is not virtuous behavior. This emulation effect, in some cases, is also at the root of speculative bubbles, where more than anything else irrationality acts.
The herd effect, is a mental trap, which leads us to enter the market by buying when everyone else is buying (so the stock is going up) and selling when everyone else is selling. If a stock is going up a lot, we are tempted to buy it. “If everyone is buying it, it means it brings profit!” This is the first trap thought that comes to mind. In fact, without technical analysis, we jump to buy when prices go up and sell when they go down. So the opposite of profit investing: buying at low prices and selling at high prices.
Why do we tend to emulate others?
We also often emulate because this attitude gives us comfort. Indeed, it comforts us to know that many others are also doing the same thing, and this prompts us to join in. Whether out of fear of making mistakes or whether out of fear of missing an opportunity for profit, we often follow the masses, the “herd” in fact.
This herd effect is characterized by irrationality (buying at high prices and selling at low prices) andemotionality.
So, in the case of trading, following what the majority does, without doing a careful analysis of the situation is very risky, also because, as all brokers go on to say, 70-80% of investors lose money .
Good technical analysis brings us greater security and saves us from large losses.
Here in onlygain’s course you find excellent techniques and also behavioral finance tips.