Much of financial theory and how to invest is based upon what the “rational person” would do. Unfortunately, as much as we would like to think so, no one is completely rational. There are no unemotional Spocks out there! Behavioral finance is the study of irrational situations that people fail to guard against in financial situations.
One of the first to learn is “herding” behavior. This takes you back to your childhood days with your friends. Did you ever do something just because all your friends are doing it? At its worst, you are doing things that your parents told you not to do because it was 1)dangerous, 2)immoral, 3)unjust, 4)whatever. You did it and when you faced your parents afterwards (if they found out!), I am sure you could hear them saying something you heard often when growing up! "You knew better. What were you thinking?" In actuality – you weren’t thinking. That is the essence of biases is that you do things without examining the basis for your decisons.
Herding behavior is pervasive in the financial markets. Sometimes the crowd can be right, but more often the “herd” can take you off some unforeseen cliff. This is when you have to “check” yourself (like a pro hockey player) and re-examine why you are doing whatever. I personally wouldn't relish being slammed up against the boards by a pro hockey player!
The key with controlling “herding” behavior is to first recognize it. Next, you need to pause and clearly think about your motivations for following the herd into whatever. We all can use some soul-searching at times. This will not totally protect you from your irrationality which is what we often are because we are human, but it can be a great place to start.
Whenever I think of herding, I find myself thinking about the movie – Marshall who are referred to as “The Thundering Herd”. If you think you need to follow the herd, just do it for the right reasons!
