12.4 Herd mentality

Investor psychology

What is herd mentality? This refers to the herd of animals which follow other animals in front of them leading the way irrespective of whether they are going in the right or wrong direction. Similarly, some investors have this mentality. In a bullish market, they try to accumulate as many shares as possible since everyone else is doing it. In a bearish market, they try to sell all the holdings as done by others. Herding reduces the time needed to properly analyze an investment decision. It can also help reduce feelings of regret if the investment choice was a bad one.

For example, Mahesh finds that Mr.A, Mr.B and Mr.C buy a particular stock. So, he too buys the same stock. Here, he is not afraid of making losses since A, B and C are also in the same situation. Consider another example: On October 19, 1987, Dow Jones Industrial Average dropped nearly 23 per cent in the largest single day decline in history, and no significant news events were reported which could account for the plunge. In a survey carried out to find the cause of the fall, a surprising two-thirds of the surveyed investors cited psychology, rather than economic considerations. As stock prices fell, investors adopted a herd mentality, causing stock prices to decline even further.