When investing, don’t run with the herd

The human "herding" instinct is also what fuels market bubbles and crashes, says Matthew Partridge.

Until very recently, most economists believed in the "efficient market hypothesis" that people always behave in a financially rational way, causing the price of shares (and other assets) perfectly to reflect all available information. Yet at best, the theory is a simplification. At worst, it is nonsense. A growing number of studies show that human psychology which is far from financially rational affects investment behaviour, leading to the emergence of a new subject, "behavioural finance".

One major factor is "herding". As far back as 1896, French psychologist Gustave Le Bon noticed that people in groups tend to copy other group members, even if the facts suggest that's not a good idea. This might be rational if the people being copied have unique information, but this herding instinct is also what fuels market bubbles and crashes. The dotcom frenzy of the late 1990s is just one recent example.

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Dr Matthew Partridge
Shares editor, MoneyWeek

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri