ESSAY: The Dangers of Herding Mentality for a Trader or Investor
All humans are attracted to the "sure thing". However, all humans have a sense of insecurity or fear of being wrong and so unconciously cling to another's direction and when that one's direction is wrong, the guilt and blame is directed to that followed person. Humans have an unconcious tendency to project their guilt and it could be anyone or anything as long as it's not self. Projection of guilt or hurt or a sense of loss as well as being wrong allows an individual to not be the responsible one and discretely escape accountability. We do this daily. When a person is in a foul mood, he or she lashes out at others either actively or passive agressively; thereby projecting their guilt and or pain. These actions provide temporary relief, but as nothing is learned, future occurrences are guaranteed.
Good traders or investors know that whenever things go wrong, they are always there to see it happen and quickly take accountability. More importantly, they forgive themselves for the mistake or error or miscalculation. There are no extended periods of regrets because the self forgiveness is only after taking accountability and so this way, one best learns from mistakes. It's discipline. And this type of discipline is the best protection against herding. Patience is not a virtue, it's a discipline and comes through practice. Patience allows one to be fearful when others are greedy and greedy when others are fearful.
Herding is dangerous to a trader. The group think mentality is also very difficult to self detect. I often see youtubers post their analysis after scanning the analysis of others. This leads to contamination of their analysis such that what seemed original no longer is and what seemed good isn't anymore. I call it the GIGO syndrome or the Garbage IN Garbage OUT. I actively try to avoid viewing or subscribing to another's analysis. I know myself because I'm human and can be influenced by reports that contradict my analysis. Long ago, I stopped subscribing to all newsletters nor do I view cnbc or any financial news outlets. I also cancelled my WallStreet Journal as well as Money Magazine. I quit relying on others and decided to rely only on my own Elliott Wave counts and Chart Patterns. It's been pretty good at helping me from herding. When it comes to Technical Analysis, self reliance is paramount so going solo is a must.
Here is an excerpt you might find interesting from The Wave Principle of Human Social Behavior, pages 395-397
Selling and Buying with the Crowd
Robert Schiller polled individual and institutional investors about why they sold stocks on October 19, 1987. Most of them admitted candidly that 'they sold because others were selling;' that is, they were herding.
It is welcome to have research telling us that the crash of 1987 was a 'psychological event.' However, no one ever thinks to poll investors about why they had bought stocks relentlessly throughout the preceding year. If any pollster did ask, the truth would be exactly the same, but the pollster would find little honesty about that fact, because in rising markets, people have plenty of time to let their neocoretexes formulate all kinds of rationalizations for herding action.
Panic is a faster-acting emotion than hope, and the neocortex is often stumped in coming up with an explanation for it. One of my favorite quotes in this regard, undoubtedly rushed out near press time, is this one from the Wall Street Journal: 'The U.S. dollar continued to decline yesterday despite economic news that could have been bullish for the currency if traders' mood weren't so bearish.'
If the Market Goes Down, It's Herding; If It Goes Up, It's ____?
Market commentators often blame a declining trend on herding, but they virtually never ascribe a rising trend to herding, as in this quote from a brokerage firm's director of investment strategy after a few weeks of price decline in a broad list of technology stocks: 'The herd mentality is taking over.' That is to say, herd mentality had nothing to do with the multi-year buying binge that preceded the decline.
The question is whether it is valid to assert, as it continually is, that psychology plays a part only in the crowd's stock-selling behavior and not its stock-purchasing behavior. A century ago, upon noticing that professional students of psychology made the same essential error n assigning only 'bad' behavior to the herd mentality, Gustave Le Bon asserted the duality of crowd behavior:
Without a doubt criminal crowds exist, but virtuous and heroic crowds, and crowds of many other kinds, are also to be met with. The crimes of crowds only constitute a particular phase of their psychology. The mental constitution of crowds is not to be learnt merely by a study of their crimes, any more than that of an individual by a mere description of vices.
The same is true of markets; one cannot understand herding behavior by studying only market crashes. One must study advances as well.
Hope Moves More Slowly Than Fear
The direction of some markets does determine, for most people, which impulsive emotion is involved. This is particularly true for stock prices, in which most people are betting on the upside. That is why uptrends look different from downtrends on a stock market graph. Hope is the fuel for advances in stocks and fear the fuel for declines. Hope, fear and complacency express themselves differently. Hope tends to build slowly, while fear often crystallizes swiftly. Nevertheless, they are both still emotions and so derive from the same motivational engine.
Regardless of which direction a market is trending, all of its governing emotions are generated by the herding impulse. In the most fundamental sense, the direction of prices does not change people's minds or their behavior. Their unconscious still follows the herd, expressing the form of the Wave Principle.