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Is it really okay to follow other investors in financial markets?

Even in an age of information and advanced technology, people still tend to follow the crowd when it comes to investing. Failing to utilize resources on the Internet or get professional help from analysts, people continue to make “compulsive, irrational decisions” believing in the wisdom of the crowd. Investment requires substantial amount of experience and knowledge on what you are investing in; one invests money into a firm, expecting a gain, that has a high degree of security for the principal amount and security of return, a process which requires thorough analysis. Therefore, investment should be driven by individualistic, logical decisions, not emotional ones. Yet, many choose to go with the flow, causing them to “behave differently from the way [they] would otherwise behave in isolation.”(http://suite101.com/article/crowd-behaviour-in-financial-markets-a100403)

This act of “[succumbing] to the lure of the crowd mentality” is called herd behavior. It is a behavior that can “cause large, unsubstantiated rallies or sell-offs, based on seemingly little fundamental evidence to justify either”(http://www.investopedia.com/terms/h/herdinstinct.asp#axzz2Aq4yvCqS). Some of the reasons for this behavior include “a lack of individual decision-making or thoughtfulness” and “the fear of regret of missing out on a good investment”. Another reason would be that people look for  leaders who believe in the majority’s opinion and is powerful enough to drive the crowd’s behavior in times of uncertainty. This non-existent leaders that people follow are “seemingly omniscient market gurus” who are, in fact, “first to crumble when the tides of mania eventually turn”(http://www.investopedia.com/articles/trading/04/011404.asp#ixzz2AqKO979B)

This behavior of individuals often brings about devastating consequences. People would buy a stock at the top of a movement and lost substantial amount of money when it starts to fall. As a korean pop star, Psy, rose to fame, thousands of koreans started to invest in D.I. Corporation, a semiconductor equipment manufacturing firm whose largest stockholder is Psy’s father. This firm has nothing to do with Psy’s success as a singer nor is any more valuable than before because of him. However, the crowd got involved in a compulsive behavior, raising the price of a share by 7 times, and lost all the money when the bubble bursted and the price of the stock hit the bottom.

Following the crowd, often times unintelligent, as can be seen in the example above, is yet a natural phenomenon. We can’t necessarily blame people for being trapped into a false sense of security. Sometimes it could be wiser to go with the flow. But when it comes to investment,  the crowd blurs one’s logical judgement and factual evidence. What’s important when determining what to  invest in is to take an individual and analytical approach that overcomes the overwhelming power of the crowd.

 

Articles and Blogs Cited

http://suite101.com/article/crowd-behaviour-in-financial-markets-a100403

http://www.investopedia.com/articles/trading/04/011404.asp#axzz2A2jHolxN

http://www.investopedia.com/articles/trading/04/011404.asp#ixzz2AqKO979B

 

 

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