Herd behaviour and the bandwagon effect are instinctive impulses to follow the actions of a crowd, despite an individual's own, better, judgment.
The term herd behaviour refers to the behaviour of sheep and cattle or other animals that seek the protection of a large group for safety from predators.
In terms of finance, however, the herd is a group of investors who are led by the moves of influential individuals to make investment choices that they may not necessarily have made on their own.
A typical example of herd behaviour is the market bubble, where an asset – or group of assets – begins to gain in value, then picks up momentum as investors begin to herd into the same investment idea or market trend.
The bandwagon effect
Herd behaviour is seen in the bandwagon effect where an individual is compelled to take a particular action because other people are doing it.
The term originates in 19th century US political campaigning when a wagon carrying a small brass band – as in a traditional circus parade – would be used by political candidates to help drum up support. Campaign followers were encouraged to "jump on the bandwagon".
It has become ubiquitous as a pejorative term for someone who supports a popular cause unquestioningly – “You're just jumping on the bandwagon".
But, in the financial world the bandwagon effect can have far-reaching consequences.
Herd behaviour and market bubbles
One of the best examples of herd behaviour and the bandwagon effect is the market bubble – both in the forming of that bubble and when it eventually, and inevitably, bursts.
Why people herd
The innate need to herd is prevalent in many animals, and it is also a human trait.
We live in groups and find the best way to organise ourselves – politically, socially and economically – is in groups.
It is ingrained in our psyche: we are told to use our common sense, that public opinion dictates, we strive to keep up with the Joneses, and we believe that the most crowded restaurant must necessarily be the best.
Mostly it is an advantageous and acceptable way of living, but this mind-set can extend into some negative and very dangerous traits.
Mob mentality, for example, can be found in some extreme forms of nationalism.