Man, by nature, is a gregarious animal, that is, he tends to live collectively. This community tends to have commonly accepted ideas (the so-called popular knowledge), which in many cases are correct, but in some cases they are wrong, leading us to make mistakes in our reasoning due to the herd effect. In this article we will see what this cognitive bias consists of, some illustrative examples and tips to avoid falling into the herd effect.
What is the herd effect?
The herd effect, also known as the "drag effect", "bandwagon effect" or "fashion effect" is the tendency to accept the reasoning or ideas of the majority as valid without analyzing whether they are correct from a logical point of view. . Possibly the herd effect is the most common cognitive bias among stock investors.
Examples of herd effect
The herd effect is present in many aspects of our life, although we may not realize it. For me, the clearest example of this cognitive bias in the world of stock investing and finance in general is the creation of bubbles.
Starting from ideas such as "internet is the future", the dotcom bubble was born, which I have already told you about my experience with her. In the same way, the Spanish real estate bubble arose from ideas that are both commonly accepted and erroneous, such as “flats never go down”, “real estate investment is the safest” or “they pay for themselves with rent”.
How to avoid the herd effect?
The herd effect tests our ability to think autonomously from what the majority think. In other words, to avoid the herd effect, a little stubbornness or stubbornness does not hurt, understanding this as the ability to go against the majority thinking.
The best way to avoid the herd effect is to analyze the reasoning behind the commonly accepted “popular wisdom”. In these cases, we must ask ourselves:
- What data is it based on?
- Is there a scientific study to confirm it?
- Is there a scientific study that disproves it?
- Are those studies rigorous?
- Does it make sense from a logical point of view?
I recommend you not forget this phrase full of wisdom from Benjamin Graham, parent of value investing:
“You will neither be right nor wrong because the crowd disagrees with you. You will be right because your data and reasoning are correct "