Chapter 4 When people begin to share the same beliefs about a particular style of investing, a herding effect can occur in the markets. At first, a small crowd starts moving into one segment of the market and, as it moves, prices rise, which causes other investors to be attracted and Wall Street analysts to start commenting. | Chaptei 4 Getting Trampled by the Herd Most investors try various markets lose money and finally acquire some knowledge through bitter experience. This is roughly analogous to learning how to drive by having a series of accidents. Samuel Case hen people begin to share the same beliefs about a particular style of investing a herding effect can occur in the markets. At first a small crowd starts moving into one segment of the market and as it moves prices rise which causes other investors to be attracted and Wall Street analysts to start commenting. If prices continue to rise the crowd grows and becomes a larger movement. Soon the crowd takes on mob-like qualities meaning that investor IQs drop to the lowest common denominator bullish rumors and opinions are elevated to important facts and doubters are ridiculed. By this point every brokerage firm and popular investment magazine is talking about the wonderful gains being made in that sector and the fantastic prospects for more gains in the future. At the same time mutual fund companies flood the market with dozens of new funds designed to capture investors chasing the trend. At the peak in prices no reason- Copyirght 2003 by The McGraw-Hill Companies Inc. Click Here for Terms of Use. 49 Protecting Your Wealth in Good Times and Bad able person will publicly question the wisdom of investing in the sector and it is the time when individual investors are about to get hurt very badly. Typically the early arrivers into a hot segment do well. But by the time the herd of individual investors gets to the feeding ground there is nothing left to eat except dirt. Unfortunately individual investors eat a lot of dirt. This chapter is an in-depth study of herding behavior and how that behavior lowers investor returns. It shows why people would be wise to ignore the noise that surrounds herding and resist the temptation to jump onto the bandwagon when a broker calls with a hot tip a coworker recommends an investment based on last .
