Herd Instinct: Social Effects on Investing and Trading

“A contrarian approach is just as foolish as a follow-the-crowd strategy. What’s required is thinking rather than polling.” -Warren Buffett

Following the crowd can be dangerous, especially when the crowd is headed off a cliff.

Investing Pioneer  – 04/15/2023 – 9:00 PM EST



I write about the economy, business, the stock market, and other markets, covering principles, methodologies, and news.

The markets are often a zero-sum game for active participants. One loses, the other wins. Speculative rallies will always by decree of reality have a large number of losers. In fact, often the most amount of capital traded precedes the great reversion to the mean.

You may have experienced this. I have. While we like to believe our own personal volition and analytical prowess is what led us choose to buy, say, a stock that at one point had significant unrealized gains, that’s not always the case.

Social influence plays a huge role in nearly all decisions, not just investing. The advent of message boards and the relatively recent great permeation of trading culture through social media made it easier than ever to make one of the single greatest errors an active investor/trader in the markets can make: following the crowd.

For investing ideas, the algorithms usually aren’t your friend (unless you are an expert at playing the trend, not something I recommend though). Even if you are half decent or great at valuating companies, if you don’t seek out securities by going down the alphabetical list yourself, it may just end up being “garbage in, garbage out”. It’s a rule as old as the markets. When a security obtains popularity in a rapid manner, it’s likely overvalued, and you can probably get it for cheaper later (only do this if the underlying investment thesis is sound).

The majority of decisions you make are shaped in some way by others. This can be a beneficial force in certain realms. Even for investing it can be – by studying the guiding principles of greats like Buffett and Graham. Soon, Investing Pioneer will be profiling noted investors, including the aforementioned, in a way that is easy to understand and digest.

Jonah Berger, author of Contagious: Why Things Catch On, polled 100 BMW owners regarding the social factors surrounding the decision to purchase their respective cars. When asked if social influence played a role in another person’s decision, people answered yes across the board. When asked about themselves… it’s a different story.

Contrarianism, in certain contexts, is the way to beat the market. Not for the mere sake of it. Binary, arbitrary decisions rarely reward the investor. Recall the Buffett quote shared at the beginning of this piece.

Some take a different approach to this conundrum. John Bogle had long recommended passive investing to ensure one earns their “fair share” of market returns. The greatest ally? Time. Unfortunately, it’s not hard to consider it one’s greatest enemy either. (Though that topic is best left to the Stoics)