By: Laura Walton AFC®
We tend to copy those around us either consciously or subconsciously. If you yawn, I yawn. I find myself crossing my arms when talking to someone whose arms are crossed. This instinct can even affect our decision making. If I don’t have enough information to make a decision on my own, I might choose to copy someone else’s decision.
This is called “social default”. In other words, my default choice is what I see others around me doing. It can also be called herd behavior. This instinct clearly affects the stock market – with not enough knowledge we follow the moves of those around us thinking they must know something we don’t. It seems the prudent thing to do but hindsight tells us it’s not. Trends to sell are triggered by fear and trends to buy are triggered by optimism – we’ve looked at the graph in our Investing Series class:
MarketPsych is a firm that tracks the mood of the market (the herd). It scans as many as 3 million articles, tweets, and blogs each day sensing fear, optimism, confusion and the like. Its CEO, Richard Peterson, made this observation about the herd in Friday’s Arizona Daily Star:
“In conditions of uncertainty, we tend to look to the herd to tell us [what] matters, and the best representation of the herd is prices. People assume the herd knows something important and has better information. The herd knows something they don’t. So when the herd starts moving, you think, ‘I better stick with them, because I’m safe if I’m with the herd.’ It’s an intelligent adaptation for use in uncertain situations, just not in the financial markets.”
His advice for the average Joe? “People have to decide if they’re going to try and time the market or sit and hold on. It you’re going to buy and hold, stop paying attention. Review once a month or once a year. You need to have discipline.” If you’ve attended our Investing Series, you’ll recognize this as the difference between a ‘trader’ and an ‘investor’.
How to avoid the herd mentality? Amy Morin, a psychotherapist, lists five ways in a piece she wrote for Forbes. To summarize, she suggests educating yourself so that you can make a well-informed decision ahead of time to avoid confusion and fear and the instinct to follow others regardless of your personal situation.
In the world of finance, this means take the time to make a financial plan that serves your long-term financial goals; a plan that you can follow with confidence and adjust to meet your needs instead of reacting to the market. The TCI Foundation is available to help you create your financial plan.