Herd Mentality Bias

The herd mentality bias describes the behavior of an individual who joins a group and starts following the actions of other group members with the belief that they have thorough knowledge on the subject at hand.

It can be extrapolated to the financial sector when an investor will succumb to the group’s flow by following and copying the plays dictated by them rather than his own strategy.

Going Against the Herd

Despite our individuality, people are hard-wired to follow the herd. Non-conformity, when choosing differently from what seems to be the group’s decision, is often correlated with a sense of fear. When one swims against the current, there is also a chance he will be made fun of because of that choice.

These perceived risks add emotional and psychological, paired with the fear of being on the wrong side of a trade, pressure towards following the herd mentality.

Herd Mentality Explained

Mentions of a herd mentality can be found in Søren Kierkegaard’s, Friedrich Nietzsche’s, Sigmund Freud’s, and Carl Jung’s works.

The thinkers at the time, however, referred to it as “the crowd”, “herd morality/instinct”, “crowd psychology”, “collective unconscious” or simply as “emulation”.

A relevant study entitled “Extraordinary Popular Delusions and the Madness of Crowds” was made in 1841 by Charles Mackay. The actual term was coined by Wilfred Totter, a surgeon, in his work entitled “Instincts of the Herd in Peace and War”.

Dotcom Bubble

The late 20^th, early 21^st century dotcom bubble is quite possibly still the leading example when it comes to demonstrating how the herd mentality bias can be applied to finance.

Investors completely disregarded the basic fundamentals of investing and gave in to the herd instincts by feverishly investing in companies which were far from being financially sound.