What is herd bias?
Herd bias, also known as the 'bandwagon effect', is a psychological phenomenon in which people rationalise that a course of action is the right one because 'everybody else' is doing it. In the world of investment, this can take the form of panic buying or selling.
Where have you heard about herd bias?
Herd behaviour is part of human nature and is often discussed as a cause of investment bubbles. A good example would be the dotcom boom of the late 1990s, when people continued feverishly investing in internet companies, despite the fact that many of these start-ups were not financially sound.
What you need to know about herd bias...
The 'word from the herd' is a disparaging expression used by those who fear that investors too often follow the crowd rather than use their judgement when choosing which assets to back. Herd bias is blamed not only for boom and bust cycles, in which asset prices escalate far above their intrinsic value before crashing to the ground but for ensuring that markets routinely over-shoot in one direction or the other. Investment fads such as indiscriminately backing tech stocks, is also blamed on herd bias among other biases. But following the crowd has its defenders, the 'momentum' investors. Their favoured expression is: "The trend is your friend."