The markets’ “herd mentality” is no secret. Examine any recent bubble and you’ll see it in full action. But exchange traded fund (ETF) investors can fight this phenomenon with a simple strategy.
Jason Zweig of The Wall Street Journal reports that some of the most informative answers to our questions about dramatic market moves such as the “flash crash” can be found in science labs. According to Zweig, studies have shown that “the value of something is likely to go up when other people tell you it is worth more” and vice versa.
In the study, researchers had 28 people submit a list of songs they wanted to buy online. Then while “a magnetic resonance imaging machine recorded the patterns of activity in their brains,” the participants were told how two music experts had rated the songs on their list.
“The brain scans showed that as soon as people learned they had chosen the same song as the experts, cells in the ventral striatum— a reward center wired with dopamine neurons that respond to pleasures like sugar and sex—fired intensely.” [Podcast: Trend Following Through Summer.]
You can only imagine the psychological effects a market bubble can have. Every time a buyer bids up an equity, the holder could be getting a jolt of dopamine in the head!
What investors need a strategy. A simple one we follow is the 200-day moving average (not herd mentality) to determine our market moves. If a position is below the 200-day average, it’s a signal to be out. If a position is above it, we are in. Of course, there are finer details that help us make decisions. (You can find some of them here: An ETF Trend Following Plan For All Seasons.) But simply put, using the 200-day moving average can help you mitigate the powerful impact emotions.
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Sumin Kim contributed to this article.