When it comes to trading stocks and derivatives, huge fortunes have been made and huge fortunes have been lost, but success normally comes down to one thing: your own intuition and research of the markets available. With a firm grip on the markets, you could be in good stead, however, one of the common patterns we see arising is what is known as herd instinct bias.
What is herd instinct bias?
Herd instinct bias occurs, in the most basic sense, whenever humans or animals see other people doing the same thing – so they follow them, as they assume it is the safest and smartest route. In a trading aspect, this means that if you see a large group of people purchasing or selling the same stocks at the same time, then you are inclined to follow what they are doing. There are a few root causes for the herd instinct bias, such as a lack of personal decision making capability or thoughtfulness, or a fear of missing out on the rewards that other investors will reap.
The problem with herding
The obvious issue with herding is the mantra that, just because everyone else is doing something, it doesn’t mean it is smart or that you should be doing it as well. In many cases, herding occurs as a result of little or no reasonable logic. Instead, it may merely have arisen as a result of the misunderstanding of a few key individuals, who were influential or visible enough for others to start following suit.
Recent examples of herd instinct bias
Generally speaking, herd instinct bias in the stock markets happens on a daily basis, but for large scale cases, we can look at financial bubbles that have occurred. The best example may be the dot-com bubble of the late 1990s. At this time, we saw rapid growth in the digital markets and greater access to computers and the internet made for more and more startups hitting the market with the latest billion-dollar idea. As a result, investors were quick to jump on board and invest in the next craze before they missed out on making huge returns. However, as you likely know, things came to a head and it became apparent that investors had paid large, over-the top sums for stakes in companies that failed to produce much or simply over promised or overestimated returns.
Generally speaking in the investment market, herd instinct bias sees a complete loss of rational thinking and less care being given to fundamental principles. In the investment market, this means that, when you make an investment, you should take the time to carry out due diligence and create an exit scheme that will give you the best chance of receiving back your investment plus returns. In severe cases of herd instinct bias, we’ve seen investors place huge sums of money into companies with no revenue, no understanding of costs and little idea on how to monetize. Instead, it is the infamous IPO that investors seek and where they expect to make huge returns on a stock that will turn out to be massively overpriced.