The Herd Mentality Trap: How Crowd Psychology Fuels Market Collapses

Have you ever purchased a stock just because everyone else was buying it? Or sold something in panic after seeing others do the same? If yes, you’ve seen the herd mentality in the stock market in action. This behaviour often feels right in the moment, but it can lead to big investing mistakes, especially during bull runs.

Let’s understand what this herd mentality really is, why so many investors follow the crowd, and how you can avoid getting caught in the trap.

• Table of contents

• What is herd mentality in investing?
• Why do people follow the crowd?
• How to make independent investing decisions

What is herd mentality in investing?

Herd mentality in investing means making decisions based on what others are doing, rather than on your own research or goals. When people see others rushing to buy a stock, they believe it must be a good move. They join in, sometimes without even knowing much about the company. This causes prices to rise quickly. However, once the excitement fades, the stock can crash just as fast, leaving many investors with losses.

Apart from stocks, the behaviour is seen with IPOs, mutual funds and cryptocurrencies. When too many people follow the crowd in investing, it causes the market to swing wildly, either by going too high or falling too low.

Read Also: Behavioral Investing: Emotion vs Strategy in Markets

Why do people follow the crowd?

There are several reasons why investors fall into the herd mentality trap:

• Fear of missing out (FOMO): Nobody wants to miss a chance to potentially make money. When friends or news reports talk about high potential returns, it creates a strong FOMO in the stock market. People rush to invest without thinking twice.
• Lack of confidence: Many investors feel they don’t know enough. So, they trust what others are doing more than their own judgement.
• Social proof: If everyone is doing something, it feels safe, even though it might not be so. Seeing a crowd move in one direction gives a false sense of security, even when the direction is wrong.
• Media noise: News channels and social media often highlight the hottest stocks, which leads to panic buying or selling.

During bull runs, when markets keep going up, herd mentality becomes stronger. Everyone feels like a winner, and it’s easy to forget the potential risks involved. This is when many people make poor decisions, buying at high prices and selling in fear when the tide turns. These are the most common investing mistakes during bull runs.

How to make independent investing decisions

Avoiding the herd doesn’t mean you ignore what’s happening in the market. It means staying calm and sticking to a clear plan. Here are some ways to make investing decisions that are right for you:

1. Know your goals: Ask yourself why you are investing. Is it for retirement, to buy a home, or to sponsor your child’s education? Your goals will help you choose suitable investments and stay focused.
2. Do your own research: Don’t rely only on tips from friends, WhatsApp groups, or online content. Learn the basics of the companies or funds you invest in. Read their financials or talk to a trusted advisor if needed.
3. Stay away from hype: Just because a stock is rising doesn’t mean it will continue rising. High excitement often leads to high risk. Remind yourself that everyone rushing into something is not always a good sign.
4. Be patient: Potential wealth creation takes time. Markets will go up and down, but if you stay invested with discipline, your chances of doing well are higher. Avoid emotional reactions to short-term movements.
5. Diversify your investments: Don’t put all your money into one stock or sector, no matter how popular it seems. Diversification reduces risk and can maintain balance when things go wrong.
6. Review, but don’t panic: It’s good to check your portfolio once in a while. If something is not performing, understand why. Avoid selling in panic just because others are doing so.

Read Also: Behavioral Finance: Meaning, Types, and Its Importance

Conclusion

Following the crowd in investing might feel easy, but it can be costly. The good news is that you can protect yourself from the effects of herd mentality in investing by staying informed and focusing on your goals. Trust yourself, and always ask if the decision is right for you. If the answer is not clear, take a step back. You’d rather miss out on a hot stock than lose your money and peace of mind. Investing is a personal journey, so don’t let the crowd decide your path.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

The content herein has been prepared on the basis of publicly available information believed to be reliable. However, Bajaj Finserv Asset Management Ltd. does not guarantee the accuracy of such information, assure its completeness or warrant such information will not be changed.The tax information (if any) in this article is based on current laws and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.