The herd mentality has been a factor in investing for centuries now, and lately it seems to be increasing. But having a strategy with your exchange traded funds (ETFs) can help you go against the grain. Do you want to know how far back herds and bubbles go? Try the Tulip Mania of 1637 on for size. It was a period in the Dutch Golden Age during which contract prices for bulbs reached high, high, higher levels until the bubble popped and prices collapsed. Bubbles aren’t just a 21st Century phenomenon.
But Brett Steenbarger at Trader Feed notes that since 2000, there has been a tremendous growth in herding behavior in the stock market, and as evidence, he cites:
- In looking at a moving window of 60 days, then counting the number of days in that window that either have 2/3 or more stocks traded as advances, or 2/3 or more as declines on the NYSE, he sees that in 2000 and 2001, one-sided days were an exception and many stocks were unchanged because stocks traded in quarter point increments
- The ratio of unchanged stocks to advancers and decliners has fallen steadily; these days, it’s unusual to have 100 unchanged stocks
- In 2000, 500 unchanged stocks was the norm
- While the investment landscape has shifted – we’re seeing more stocks in ETFs, for example – the average number of issues traded daily since 2000 has fallen
- However, there is more money and more money managers chasing the same returns and, in effect, chasing one another
Herding is an emotional response to what’s happening in the market, and it’s not going to go away, especially not if it’s been around since at least the mid-1600s!
Eliminating emotions is every investor’s challenge, but it can be done by having an entry and an exit strategy. By watching trend lines to spot opportunities, you’ll find yourself positioning yourself in case of a potential long-term uptrend (as opposed to buying something that’s trending higher just because it’s what everyone’s doing). On the downside, selling when a position drops below its long-term trend line or 8% off its recent high, you can help stop the bleeding and avoid hanging on for far longer than you should have.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.