Investing 101: Do you exhibit the herding behaviour?

An acquaintance of mine told me he bought a stock with “high growth potential” and as an analyst, I was eager to understand the kind of analysis that he had carried out. I asked if he used various conventional valuation techniques and to my amazement, he said, “My uncle’s bought it and I hear Mr. X is also buying…” Ordinarily, this could be a good thing as experienced investors are usually a good source of information (though you need to do your own investigation). However, when I asked if he had probed them on why they purchased the stocks he said, “I don’t care, if it is good for them it is good for me too”. Really?!

This is called “herding”.  Just because someone “regarded highly” buys a stock, other people may see it as a good investment and just dive in. No analysis. No questions. Not even, what makes this a good investment? The truth is, herding has been observed to happen even with experienced financial professionals (I mean no disrespect) so if you do this, don’t worry, you are not alone. However, just to be clear, a good investor would carry
out his/ her own assessment – just in case.

There are a few problems with this behaviour that includes spending money on the stock you don’t need or buying an overvalued company’s shares (at the wrong time I might add). Any of these can potentially lead to loss of money, financial strain, and all-around sorrow. I have been there too, several times actually. Now, when I read of the latest “hot stock”, my first
action is to carry out stock analysis before anything else!

Solutions?  Well in my opinion, there 3 ways we can control our herding behaviour:

  1. There are financial advisory service providers out there. Register (or if you are already registered) with one, ask them what they think of the stock as it relates to your own portfolio and goals.
  2. If you are confident enough to handle it yourself, steer clear of the investment first then review. This will help you reduce your bias for or against the stock. It will also double as a means of checking if the stock is actually optimal for your unique investment situation (more on this in another post).
  3. Finally, keep your eyes on this blog. It is a free service and you may find information that could be of help whether you are experienced at investing or not.

Remember that there is no shortcut to stock market success. Till the next post…