Recency Bias And Herd Behaviour: The Double Trap In Bull Markets

When stock markets are rising, it is natural to feel hopeful and excited. Many new investors enter at such times, assuming they may be able to earn quick returns. However, there are two common traps here that often shape how people invest in bull markets. These are called recency bias and herd behaviour.

Table of contents

• What is recency bias and herd behaviour?
• How the two phenomena interact in rising markets
• Historic examples of bubbles and crashes
• The risks of following short-term trends
• Strategies to maintain a long-term perspective

What is recency bias and herd behaviour?

• Recency bias is the tendency to believe that what has happened recently will continue to happen in the future. For example, if a stock has gone up for a few months, people may assume that it will keep rising, even if there are no strong reasons behind it. This is known as recency bias.
• Herd behaviour is the tendency to copy what others are doing. When friends and family are all buying the same stock, people often feel pressured to do the same. This is how herd behavior works.

Both these tendencies are common and natural, but they may create problems in a rising market when combined with strong emotions.

Also Read: How Recency Bias Can Impact Mutual Fund

How the two phenomena interact in rising markets

A rising market, or bull market, may make many investors feel that opportunities are everywhere. Prices keep moving up, and news and social media discussions add to the excitement, and bull market psychology takes hold.

• Recency bias might lead investors to believe that recent gains will continue.
• Herd behaviour might make them feel safe when they see others buying.
• Together, this leads to FOMO trading, or the fear of missing out on quick potential profits.

This can push stock prices higher than what the actual value of companies may justify. Investor behaviour in rallies can easily distract from careful decision-making.

Historic examples of bubbles and crashes

History offers many lessons about what happens when recency bias and herd behaviour dominate.

• Dot-com bubble (late 1990s to 2000s): Technology stocks across the world soared because investors believed internet companies would deliver high returns. Many followed the crowd, leading to inflated valuations. When reality set in, prices fell sharply.
• Housing bubble (2007-08): Easy money and herd-like buying in the US property markets made many believe prices could never fall. The global financial crisis showed how damaging that belief could be.
• Local stock market rallies: Even in India, there have been phases where certain sectors (like IT in early 2000s, or small cap stocks during short bursts) rose rapidly, only to correct heavily later.

The risks of following short-term trends

Chasing trends without understanding the real value of investments can be risky. Some of the pitfalls include:

• Buying at high prices: Herd behaviour often pushes investors to enter when prices are already stretched.
• Overconfidence: Recency bias may create the false belief that gains are easy and quick.
• Panic selling later: When the market corrects, the same herd often exits together, leading to steep losses.
• Neglecting fundamentals: In the rush of FOMO trading, company earnings, business models, and risks may get ignored.

Short-term thinking might bring quick wins for some, but for many it can create losses, stress and avoidable mistakes.

Strategies to maintain a long-term perspective

Investors can take simple steps to reduce the effect of recency bias and herd behaviour:

• Pause before acting: If a stock has risen fast, take time to check whether its value justifies the price. Rising prices alone do not guarantee success.
• Diversify: Distribute your investments across sectors and asset classes. In case a stock or a theme underperforms, the impact on your portfolio may be minimised.
• Set personal goals: Instead of copying others, link investments to your own needs such as retirement, education, or a home purchase.
• Review regularly, not daily: Constantly tracking prices can feed short-term emotions. A periodic review keeps focus on the bigger picture.
• Seek balanced advice: Talking to trusted financial planners or reading diverse views helps get a balanced perspective.

Also Read: Impact of Behavioural Biases on Investment Decisions

Conclusion

• Recency bias and herd behaviour are common in rising markets, but they can cloud judgement.
• Together, they can lead to short-term decisions that may not always work out. History shows many examples of rallies followed by sharp corrections.
• Focusing on long-term goals, diversifying, and avoiding emotional decisions can help protect investors.
• A cautious approach can reduce stress and allow potentially steady progress.

At Bajaj Finserv AMC, we recognise that emotions are the cornerstone of investor behaviour – not just for investors but for investment professionals too. That’s why, behavioural finance is at the heart of our investment philosophy, InQuBe, which combines the Information Edge, Quantitative Edge and Behavioural Edge. By understanding, tracking and monitoring market sentiments and our own investment biases, we seek to make mindful and strategic investment decisions. Get the Behavioural edge by investing with Bajaj Finserv AMC. Read more about InQuBe here.

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