Herd Mentality

Herd mentality is the behavior exhibited by individuals who are influenced by the collective group into thinking and behaving similarly as the group.
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In investing, herd mentality, or herding, is evident in the large combined capital of the investing public, leading to strong trends in asset prices. Herding is similar to groupthink and crowd psychology.

Unlike contrarian investing, where investors seek to allocate capital in ways that are opposed to the thinking of the majority of the public, herding typically follows the biases of the masses, often because it appears “safe.” Herd mentality can lead to strong price trends and, ultimately, asset bubbles.

Contrarian investing is built upon the notion of profiting from mispriced assets that result from one-sided investing. Many sentiment and market studies, such as the put/call ratio, are contrarian indicators where investors seek to benefit from a change in the direction of the investing herd. Strategies such as mean-reversion trading also look to capitalize on contrarian thinking as investors look for retracements from strong, one-sided, trending price action.

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FAQs

What is herding in finance?

Herd mentality is the behavior exhibited by individuals influenced by the collective group into thinking and behaving similarly as the group. In investing, herd mentality, or herding, is evident in the large combined capital of the investing public, leading to strong trends in asset prices. Herding is similar to groupthink and crowd psychology. 

What causes herd mentality?

Herd mentality typically follows the biases of the masses, often because it appears “safe.” Herding is the behavior exhibited by individuals who are influenced by the collective group into thinking and behaving similarly as the group. Herd mentality can lead to strong price trends and, ultimately, asset bubbles.

What is an example of herd behavior?

There are numerous examples of herd behavior in financial markets throughout history. Herd mentality is most often seen in asset bubbles and stems from a fear of missing out.

The tech bubble in the early part of the 21st century is a prime example of herd behavior, as investors poured money into the stock market without regard for earnings prospects, proper research, or risk management.

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