April 19, 2024

Business Bib

Business & Finance Blog

Reason Why Traders Follow The Herd

3 min read

Hispanic young male stock trader typing on keyboard while using computer at home

There are many reasons why traders tend to follow the herd instead of intelligently deciding for themselves. In this article, we’re going to talk about those reasons and why you should be aware if you are heavily influenced by them as you wade in the trading world.

Greed

One such reason is greed, which is quite overwhelming and difficult to overcome. When people feel greedy and they don’t control it, they almost always end up losing. Meanwhile, it requires a tremendous amount of trading discipline to overcome greed.

Fear of being Different

Additionally, people tend to follow the herd in fear of having a contrary view and doing something different, which they think could make them fail while others succeed. The concern of falling behind peers is what pushes most to simply go with the flow. When he or she loses, others also lose.

Leadership

When people follow the herd, there’s almost always that urge to find a leader. This is pretty normal with any societal structure. In terms of who should be the leader, it could be one person, a group of people, or even just the majority of the crowd’s opinion.

People want a leader who will lead them to the right decision, particularly during tight and uncertain market conditions. On the other hand, history has shown us that blindly following a so-called leader could lead to negative results.

When people blindly follow the leadership of someone, they typically fail to see the turning point of the trend. 

Imminent Reversal

When there’s an apparent uptrend, all individual traders and non-professionals typically follow the group and enter a position or add to an existing one. However, prices eventually exceed a limit. That means that the market wouldn’t be able to sustain the gains.

While players still have the money, the market will be driven higher. When they are already fully invested, the market hits an extreme level, called overbought.

During this time, the prices do not only lose their upward steam. They also reverse and correct the price in the opposite direction.

Contrarian Opinion

Contrarian trading is the opposite of following crowd behavior. Contrarian traders usually go against the flow and hold beliefs that oppose widely accepted market opinions.

On the other hand, succeeding with this kind of strategy is considered to be very difficult, particularly when the current market movement is supported by a consistent flow of supporting fundamental indicator.

Contrarian trading is very risky. Therefore, only highly experienced professionals use it as their trading strategy.

Overall, what a smart trader can do is to follow the crowd when the sentiment agrees with his or her own analysis and conclusions backed by data and indicators. If otherwise, get out of the trade.

Avoid being Greedy

Meanwhile, you will almost certainly experience greed at this point. You will find yourself stuck and thinking whether you should get out of the trade as the indicators say or stay on it to squeeze in some extra profits.

There are instances where either can provide you some benefit. In the longer term, however, having discipline and holding on to your strategy will prove to be the more beneficial and profitable.