I Herd, You Herd, We Herd

In financial markets, the crowd is the perceived leader, but it comprises nothing but followers.


One of the fundamental revelations of the Elliott Wave Principle is that investors herd.


For any thinking, independent person, that's a hard idea to accept. The Socionomics Institute's Alan Hall recently explained herding in an interview with Esquire magazine, and:

"People do hate this theory, Hall admits. Nobody wants to think that he's engaged in 'pre-rational survival behavior,' that he's no smarter than a gnu on the Serengeti, that rumors and movies and hemlines and even politics are just our way of sniffing the wind -- that history itself is just a glorified herding pattern."


But as hard as it is to swallow, let me give you an example of herding behavior that I myself recently engaged in -- perhaps you have too.

The other day, my wife and I went to a concert. We parked farther away from the venue than we would have liked -- so far, in fact, that we couldn't see the place, and it took us a minute to figure out which direction to go. We weren't the only ones trying to save a buck on parking -- there were 10-15 other people locking their cars.

The concert venue sits in the middle of a busy downtown area. I'd been there only once before and remembered having trouble finding it. Others have probably felt the same way -- I say that because as we all were leaving the parking lot, everyone kind of, sort of... well, formed a herd. A few people toward the front looked confident enough in the direction they'd chosen. The rest of us followed. We figured the ones upfront knew where they were going.

As we walked -- this group of people stretched along the sidewalk for half-a-block -- it occurred to me that if those at the front suddenly stopped, or turned into a bar, then my wife and I and most others in the group would likely feel lost. Yes, we would have kept going to save ourselves the embarrassment. But we would do so without really knowing where we were going, and only hoping to get there in time.

That's when I wished I had my TomTom GPS navigator with us.

It's the same in investing. There are stock exchanges in New York, London and other major cities. There are financial experts out there who seem confident about the market's direction. The rest of us, well... We watch, we listen, we share our own viewpoints -- but ultimately, most of us follow. When stocks go up -- "they are buying!" -- we buy. When stocks go down -- "they are selling!" -- we sell. In the absence of information, we rely on behavior of others.

Here's an important question, though. Walking to the concert, we could see our "leaders." But who "leads" investors? Here's how Elliott Wave International's founder and president Robert Prechter answered that in his May 2009 Elliott Wave Theorist:

Market Herding
Have you ever watched a dog interact with its owner? The dog repeatedly looks at the owner, taking cues constantly. The owner is the leader, and the dog is a pack animal alert for every cue of what the owner wants it to do.

Participants in the stock market are doing something similar. They constantly watch their fellows, alert for every clue of what they will do next. The difference is that there is no leader. The crowd is the perceived leader, but it comprises nothing but followers. When there is no leader to set the course, the herd cues only off itself, making the mood of the herd the only factor directing its actions.

Another term for "the mood of the herd" is social mood. It changes according to the patterns R.N. Elliott first described in the 1930s. These patterns reflect social mood changes -- and in turn make financial markets predictable.

Eduard Hamamjian
GeaSphere LLC