Behavioral finance FAQ / Glossary (Herding)

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Dates of related message(s) in the Behavioral-Finance group (*):

Year/month, d: developed / discussed, i: incidental

Herd instinct, behavior, mentality,

Herding

 

Seen in many messages, as it is a Behavioral Finance classic

+ see also collective biases, crowd behavior, (rational) expectations,

cascades, trend following, consensus, laziness, groupthink,

contagion, conformity, epidemic, peer pressure + bfdef2

The more, the merrier, certainly!

The more, the stronger, maybe!
The more, the wiser, maybe not!

Definitions

Hearts beat together,

Minds think together,

Mouths sing together,

Feet walk together,

People ...trip and fall together.

To make it simple,

Herding (or flocking, swarming..) / herd instinct / herd behavior /

herd mentality, when applied to human beings, describes how, from

time to time, nearly everybody thinks, decides, and

acts in the same way, as a single entity

More academically, herding is a social psychology allegory (*).

It is an extension of aping / mimicry to a whole crowd

It describes a contagious emotional, cognitive

and reflexive phenomenon that is rather common

among large human groups.

A related phenomenon is peer conformity (see those words)

(*) Aristotle, or maybe St Tomas de Aquino, was the first to call the human being a "social animal".

An ambiguous compliment!

Such a collective phenomenon happens when a group or a mass (for example the bulk of investors)

adopts, as if it were a single body (herd) and without clear rational (*) motive:

A common - positive or negative - attitude,

And - here the effects becomes crucial - a common behavior,

sometimes a highly irrational and excessive one.

(*) Of course, to think that other people have more experience and knowledge than us in some areas and

cases, and that to do in Rome like the Romans do, is sometimes wise (see the "individual effects" section),

but on condition to be ready to analyze further if those people are not enslaved by habits and mimicries.

How does herding start?

Instinct only? Or some shepherd's act involved?

Herding can be either spontaneous or manipulated:

1) Spontaneous, in an instantaneous or gradual way:

It might surge under the collective emotion due to an extreme social shock,

Or it can spread among people progressively.

A common perception of some situation builds strength.

All the more if it is buttressed by a cold analysis done in common.

But usually it is associated with a growing collective feeling,

such as enthusiasm or discontent, or the good old "fear and hope",

or whatever positive or negative common sentiment or mood.

2) Or "helped" by people who know they can play on that potential instinct

and find their own advantage in manipulating it.

All along History, cult gurus populist politicians or ideological

factions have found ways to manipulate human

groups, masses or crowds into herds.

This domineering influence blocks everybody's mind towards only one direction,

with often disastrous consequences.

The herding instinct: possible genetic origins

Feeling warm, comfortable and safe against big bad wolves?

Emotions and cognitions don't seem to be the only factors that lead to herding.

Old genetic instincts seem involved too.

The herd instinct combines beliefs and behavioral reflexes.

It might come from the old "animal brain" anchored on the "predator-prey" (wolves and sheep) phenomenon.

Grouping and moving together was a strategy by some "prey" species to get protection from predators,

which hesitated to attack a full mass of individuals.

Predators, on their side, might have found an advantage in attacking as a pack. Save the predators?

More generally, social cohesion, solidarity, cooperation, common organization suppose common

feelings(see affect heuristic, empathy, genetic utility...). Groups are emerging / self organizing

bodies that are consistent with the usual evolution of dynamical systems (see that word).

On the other hand this tendency to stick together can also create distrust and hostility between
several groups and populations.

Whence comes a feeling of safety, comfort and well being

in behaving in harmony with the group, in the warm proximity of

other human beings. There is some affect heuristic here (see that phrase)

There is also some fear added, as it seems to work in two ways:

Avoiding to feel alone might compensate the anguish due to the uncertainty aversion.

The fear to be crushed by the group (see "peer pressure") if a member dissents

seems also to favor herding.

Herding is therefore not only a collective cognitive phenomenon (like in an information cascade,

or in social learning), but quite often also an emotional expression of collective hope/greed and fear.

The individual effects

It makes you wise? Or foolish?

"In Rome, do like the Romans" is sometimes an appropriate reaction.

Better admit that the Romans knew what were the wise things to do in Rome.

But in other circumstances, or when it gets excessive and purely emotional,

such a conformity might override individual reasoning and behavioral inhibitions.

Here the group paralyzes individual thinking

and takes the driver seat like an autopilot.

This not only can cause collective erroneous behaviors but also

it makes the individual act unconsciously against its real interest, goals and values.

Herding in economic and financial markets

Herding towards money pastures, or to fall over the cliff.

In economic and financial markets, it is not uncommon

for most investors to have similar expectations at the

same time on future prices and returns.

For example, in stock markets, there are periods when nearly all investors (even professional ones) get

1) bullish (= thinking that prices will rise)

or

2) bearish (thinking they will fall).

In case 1) buyers become ready to buy at any price and sellers to sell only at a higher price

In case 2) sellers become ready to sell at any price and buyers to buy only at a lower price.

=> As market prices result from buyers meeting sellers in the same racing field,

that combination pushes prices up in case 1) and down in case 2).

When those attitudes self-feed for too long, the related market trends can degenerate

into bubbles and crashes.

This collective bias contradicts in some respect at least

three standard economic theories:

The idea that every economic agents is independent of the other ones in taking its decisions.

The law of supply and demand according to which higher prices are supposed to attract

more sellers and deter buyers (*).

The idea that asset prices give pure information about fundamentals.

Actually, prices give a mix of information, not easy to untangle, as well about hard facts

as about the crowd's mood.

(*) At least in financial asset markets (stocks...). In commodity markets the law of offer and demand

works better. Herding, and the related price momentum exist but they have a shorter life: after a while

price rises attract less demand and price falls more demand.

Herding can come in various flavors, some of them near-rational

What makes us imitators?

A cool sense of interest? Or just laziness?

Or the magnetic attraction of some collective good or bad feeling?

Rational herding.

Sometimes, herding obeys an apparent rationality , as the Roman allegory seen above tells.

The idea is "as the others do it, they must have a reason"

We have here what is called "rational herding", "rational expectations", or "information cascades"

(see those phrases) and also the "beauty contest" allegory.

But such sequences of rational imitations that spread from people to people could also be called

"perverse rationality" when they become obviously excessive

Herding by neglect. Herding could also be due to pure laziness :

to follow the trend spares further information research and analysis.

Well, this "time and effort saving bias" can also be considered as a kind of raw rationality.

Emotional herding. But quite often herding is an emotional

contagion (crowd / mass behavior).

In such cases, emotions (like greed, hope or fear) take control.

A massive and persistent herding is typically emotional and can get more and more so.

This differs from a simple information cascade, which is more fragile, as it is based

more on - a reversible - thinking or reflex and less on pervasive feelings.

(*)To find those messages: reach that Behavioral-Finance group and, once you are there, 1) click "messages", 2) enter your query in "search archives".

Members of the Behavioral Finance Group, please vote on the glossary quality at Behavioral-Finance/polls

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