Herding behavior refers to the tendency of an individual to follow the crowd because the decisions made by the majority are assumed to always be correct. The herding individual will base an investment decision on the crowd actions of buying and selling, creating speculative bubbles. This, in turn, makes markets inefficient, a direct conflict with the efficient market hypothesis. There is a consensus that the herd is usually wrong, which contributes to market volatility.
The impact of herding is not limited to retail investors; some of the academic literature suggests that herding is even more prevalent with institutional investors than it is with individual investors. A logical conclusion that can be drawn from herding behavior is that prices will overshoot what is rational in both directions. Stocks that are currently fashionable will be excessively expensive. When they cease to be fashionable, prices will plummet back toward the rational.
Last Updated: 6/25/2018