Observations - Herd Mentality
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OBSERVATIONS – HERD MENTALITY
Sunday, June 18, 2006
In one month (May-June) the Indian stock markets feel a whopping 30%, hitting a low of 8799 on June 14, 2006. The fall illuminated the my-actions-are-governed-by-those-of-my-neighbour’s behaviour. In this article I shall write on Herd Mentality & the beauties of Logic…it is indeed beautiful…
On Herd Mentality The freefall experienced in the markets over the past two weeks gave me some more interesting insights into human thinking or the lack of it! The markets put on display, & stretched beyond any imagination, the meaning of the word ‘herd mentality’. Picture this. A ‘BIG’ Foreign Institutional Investor (FII) gets out a report saying that the Indian market is ‘over-valued’ & warrants a bit of correction &…plunge! Down the market goes correcting almost 30%. Who are the losers? Naïve investors & late entrants into the rally who thought that the party would never end got a smack on their rears. Did these guys even wonder if the FII had already sold off his holdings before getting out the ‘intelligent’ report? I always knew it’s against human nature to accept things as they are. The above event only gave more proof to that belief. Everyone from the neighbor, to the news channels, to the government was blamed for the downfall. I fail to understand these flip-flops by humans especially when they are put in a corner. Maybe that’s the reason why they have solitary cells in prison. Some wise guy understood that if cornered, humans would first blame everyone else & in that process itself the ‘real’ culprit would be given away! I laud him! When the markets were rising & people were making money by the dozen, the government was the ‘best’ & the idiots squeaking on the news channels were the ‘smartest’ guys in the business who knew what they were talking. Markets drop. SWISSSSHH! All this talk evaporates in an instant. & Then only ‘bad’ guys everywhere! Flippant? It amazes me even further how humans when running in the same direction, ‘choose’ to ignore the warning signs that the markets put up on their roads every now & then. They do it thinking its all an illusion…but at the end they discover that they have come up to a point where their roads are an illusion & all that awaits them at the next step is a cliff! & They still jump, thinking that some magic force will invent a cushion when they land on their backsides! Optimism? I can see the concept of ‘Inertia’ flashing before my eyes. I can also see Newton’s Laws of Motion floating in my brain. How prophetic was he! He might not have had the slightest idea that his path breaking Law would have implications outside Physics too! The bigger problem with our race is that we think the majority is always correct. & Behave in contradictory fashion when the need of the hour is rational behavior. Its like people running like hell when they hear ‘fire’. All logic is thrown to winds & the only desire is to save ones own ass. & invariably the ass gets burnt in the process. The herd mentality is not restricted to individual investors alone, even the ‘big’ guys seem to suffer from the same disease. Three days of successive fall & all brokerages & institutions fall over one another in hooting that it’s a bear market & things have changed for the worse. Changed in a day? Beats all logic. I don’t understand this too. Suddenly, everybody focuses on Sell numbers, which investing celebrity has negative things to say about the stock market & valuations now ‘look’ stretched. Suddenly the ‘bottom’ searching is the most important question on everybody’s minds. I don’t understand how one can predict the ‘Top’ or the ‘Bottom’. It’s tantamount to predicting the behavior of a collection of people. I don’t know what word to use for describing this tendency. I am not a big fan of astrology but I think in this case astrology is better…as it tries to predict the effect of planets on us. & Trying to predict a planet’s motion is much more logical than trying to predict human behavior.
Hemant Sreeraman
-1–
Hope…can’t substitute Reason
OBSERVATIONS – HERD MENTALITY
Sunday, June 18, 2006
On Logic…or the lack of it… The very same guys, who bought a stock at Rs.X a month back, on the premise that it’s under-priced, were the first ones to dump it when the markets took a U-turn. They were selling when, ideally, they should have been buying more! What happened to the confidence? Do fundamentals change with perception? Or market levels? They are independent events that should not influence an investor’s thought & decision making process. I wonder what makes people behave the way they do. Its almost always contradictory to what is required on the occasion. I am no super human & I have committed errors too. But that hasn’t stopped me from trying to understand or question or marvel at human behavior. We are ‘straight’ when we should actually be taking a ‘U’ turn & take a ‘U’ turn when we should actually be ‘straight’!!! All the happenings make me think that investing is not so much about fundamentals, technicals, ‘economicals’ or ‘statisticals’ (pardon those terms) as much as it is about your neighbor’s behavior. The R-Squared metric tells us how much of the variation of the dependent variable can be explained by the independent variable. Invariably, the independent variable is the market & we speak of ‘X% of a stock’s variation can be explained by the market.’ I wonder if we should have the ‘neighbor’ as the independent variable & the ‘individual’ as the dependent! If we expand this to the entire population, the result would be an intertwined web of human behavior…that would, in all probabilities, be a contradiction in itself! So, finally who influences whom? (Newton’s 3rd Law of Motion floats in my brain) Answer. Both… Physics & the markets seem inextricably linked to me. Physics believes that all bodies in this universe are forever ‘exerting’ a force on another body & vice versa. This force is termed ‘gravity’. The same thing happens in the markets & market participants too. The US markets shoot up & the world markets follow suit. US investors buy & the world investors follow them. My neighbor sells & I follow him. & My neighbor follows me! Only difference, I think, is that the ‘gravity’ should be replaced with ‘stupidity’…most times at least. On those few occasions when ‘behavior’ is actually one with what is called for, I will term it ‘serendipity’!!! My thoughts have led me to a place where I now am beginning to question the very utility of ‘fundamental’ analysis. If its stupidity that influences behavior, most times, what is the point in digging deep in financial statements to unearth ‘value’?
Hemant Sreeraman
-2–
Hope…can’t substitute Reason
Sunday, June 18, 2006
In one month (May-June) the Indian stock markets feel a whopping 30%, hitting a low of 8799 on June 14, 2006. The fall illuminated the my-actions-are-governed-by-those-of-my-neighbour’s behaviour. In this article I shall write on Herd Mentality & the beauties of Logic…it is indeed beautiful…
On Herd Mentality The freefall experienced in the markets over the past two weeks gave me some more interesting insights into human thinking or the lack of it! The markets put on display, & stretched beyond any imagination, the meaning of the word ‘herd mentality’. Picture this. A ‘BIG’ Foreign Institutional Investor (FII) gets out a report saying that the Indian market is ‘over-valued’ & warrants a bit of correction &…plunge! Down the market goes correcting almost 30%. Who are the losers? Naïve investors & late entrants into the rally who thought that the party would never end got a smack on their rears. Did these guys even wonder if the FII had already sold off his holdings before getting out the ‘intelligent’ report? I always knew it’s against human nature to accept things as they are. The above event only gave more proof to that belief. Everyone from the neighbor, to the news channels, to the government was blamed for the downfall. I fail to understand these flip-flops by humans especially when they are put in a corner. Maybe that’s the reason why they have solitary cells in prison. Some wise guy understood that if cornered, humans would first blame everyone else & in that process itself the ‘real’ culprit would be given away! I laud him! When the markets were rising & people were making money by the dozen, the government was the ‘best’ & the idiots squeaking on the news channels were the ‘smartest’ guys in the business who knew what they were talking. Markets drop. SWISSSSHH! All this talk evaporates in an instant. & Then only ‘bad’ guys everywhere! Flippant? It amazes me even further how humans when running in the same direction, ‘choose’ to ignore the warning signs that the markets put up on their roads every now & then. They do it thinking its all an illusion…but at the end they discover that they have come up to a point where their roads are an illusion & all that awaits them at the next step is a cliff! & They still jump, thinking that some magic force will invent a cushion when they land on their backsides! Optimism? I can see the concept of ‘Inertia’ flashing before my eyes. I can also see Newton’s Laws of Motion floating in my brain. How prophetic was he! He might not have had the slightest idea that his path breaking Law would have implications outside Physics too! The bigger problem with our race is that we think the majority is always correct. & Behave in contradictory fashion when the need of the hour is rational behavior. Its like people running like hell when they hear ‘fire’. All logic is thrown to winds & the only desire is to save ones own ass. & invariably the ass gets burnt in the process. The herd mentality is not restricted to individual investors alone, even the ‘big’ guys seem to suffer from the same disease. Three days of successive fall & all brokerages & institutions fall over one another in hooting that it’s a bear market & things have changed for the worse. Changed in a day? Beats all logic. I don’t understand this too. Suddenly, everybody focuses on Sell numbers, which investing celebrity has negative things to say about the stock market & valuations now ‘look’ stretched. Suddenly the ‘bottom’ searching is the most important question on everybody’s minds. I don’t understand how one can predict the ‘Top’ or the ‘Bottom’. It’s tantamount to predicting the behavior of a collection of people. I don’t know what word to use for describing this tendency. I am not a big fan of astrology but I think in this case astrology is better…as it tries to predict the effect of planets on us. & Trying to predict a planet’s motion is much more logical than trying to predict human behavior.
Hemant Sreeraman
-1–
Hope…can’t substitute Reason
OBSERVATIONS – HERD MENTALITY
Sunday, June 18, 2006
On Logic…or the lack of it… The very same guys, who bought a stock at Rs.X a month back, on the premise that it’s under-priced, were the first ones to dump it when the markets took a U-turn. They were selling when, ideally, they should have been buying more! What happened to the confidence? Do fundamentals change with perception? Or market levels? They are independent events that should not influence an investor’s thought & decision making process. I wonder what makes people behave the way they do. Its almost always contradictory to what is required on the occasion. I am no super human & I have committed errors too. But that hasn’t stopped me from trying to understand or question or marvel at human behavior. We are ‘straight’ when we should actually be taking a ‘U’ turn & take a ‘U’ turn when we should actually be ‘straight’!!! All the happenings make me think that investing is not so much about fundamentals, technicals, ‘economicals’ or ‘statisticals’ (pardon those terms) as much as it is about your neighbor’s behavior. The R-Squared metric tells us how much of the variation of the dependent variable can be explained by the independent variable. Invariably, the independent variable is the market & we speak of ‘X% of a stock’s variation can be explained by the market.’ I wonder if we should have the ‘neighbor’ as the independent variable & the ‘individual’ as the dependent! If we expand this to the entire population, the result would be an intertwined web of human behavior…that would, in all probabilities, be a contradiction in itself! So, finally who influences whom? (Newton’s 3rd Law of Motion floats in my brain) Answer. Both… Physics & the markets seem inextricably linked to me. Physics believes that all bodies in this universe are forever ‘exerting’ a force on another body & vice versa. This force is termed ‘gravity’. The same thing happens in the markets & market participants too. The US markets shoot up & the world markets follow suit. US investors buy & the world investors follow them. My neighbor sells & I follow him. & My neighbor follows me! Only difference, I think, is that the ‘gravity’ should be replaced with ‘stupidity’…most times at least. On those few occasions when ‘behavior’ is actually one with what is called for, I will term it ‘serendipity’!!! My thoughts have led me to a place where I now am beginning to question the very utility of ‘fundamental’ analysis. If its stupidity that influences behavior, most times, what is the point in digging deep in financial statements to unearth ‘value’?
Hemant Sreeraman
-2–
Hope…can’t substitute Reason
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