Herding

The Story

In 2021, a wave of excitement swept through UK investing forums. Everyone was talking about meme stocks, cryptocurrency, and "the next big thing." Tom, a 28-year-old software developer in Manchester, had been sensibly paying into his workplace pension and a Lifetime ISA. But watching colleagues and Reddit threads celebrate huge gains, he felt he was missing out.

Tom moved £8,000 from his savings into speculative crypto tokens and meme stocks. He didn't research the fundamentals — he didn't need to, he thought, because thousands of others were buying. Within six months, his £8,000 was worth £2,100. The herd had stampeded off a cliff, and Tom went with them.

What Is Herding?

Herding is our tendency to follow the actions of a larger group, especially under uncertainty. When we don't know what to do, we look at what others are doing and copy them. It's an evolutionary instinct — following the group kept our ancestors alive — but in financial markets, it creates bubbles and crashes.

The logic feels sound: "If millions of people are buying this, they must know something." But markets don't work by majority vote. When everyone is buying, prices are inflated. When everyone panics and sells, prices collapse below fair value. The herd is almost always late.

Herding in Finance

Herding has driven every major financial bubble in history. The South Sea Bubble of 1720 — a very British disaster — saw everyone from Isaac Newton to household servants piling into shares of the South Sea Company. Newton himself lost £20,000 (roughly £4 million today) and reportedly said, "I can calculate the motion of heavenly bodies, but not the madness of people."

Research by Banerjee (1992) and Bikhchandani, Hirshleifer, and Welch (1992) formalised how herding creates "information cascades" — situations where people ignore their own private information and follow the crowd, causing markets to move far from fundamental values.

In the UK, herding fuelled the buy-to-let frenzy of the 2000s. Property prices rose, so more people bought investment properties, pushing prices higher still. When the 2008 financial crisis hit, many leveraged landlords found themselves in negative equity. The herd had created the very bubble it was now trapped in.

"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one." — Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (1841). Scharfstein and Stein (1990) showed that even professional fund managers herd, partly because it's safer for their careers to fail conventionally than to succeed unconventionally.

How to Protect Yourself

Have a written investment plan. Before you invest a penny, write down your goals, time horizon, and asset allocation. When the herd tempts you, refer back to your plan.

Be suspicious of "everyone's doing it." If a particular investment is dominating headlines and dinner party conversations, you're probably late. The best time to buy is when nobody's talking about it.

Automate your investing. A monthly direct debit into a diversified index fund removes the temptation to chase whatever the crowd is excited about this month.

Limit your exposure to financial social media. Reddit, Twitter, and TikTok are herding machines. They amplify excitement and create false consensus. Consume financial information from boring, evidence-based sources instead.

Remember that bubbles feel rational from inside. During every bubble, participants have convincing stories for why "this time it's different." It never is.

Reflection Questions

• Have you ever bought an investment primarily because other people were buying it?
• How do you distinguish between genuine market opportunity and herd-driven hype?
• What sources of financial information do you consume, and do they encourage independent thinking or groupthink?

Research Note

Key references: Banerjee, A.V. (1992) "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, 107(3), pp. 797-817. Bikhchandani, S., Hirshleifer, D. and Welch, I. (1992) "A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades," Journal of Political Economy, 100(5), pp. 992-1026. Scharfstein, D.S. and Stein, J.C. (1990) "Herd Behavior and Investment," The American Economic Review, 80(3), pp. 465-479.