An acquaintance of mine told me he bought a stock with “high growth potential” and as an analyst I was eager to understand the kind of analysis that he had carried out.
I asked if he used various conventional valuation techniques and to my amazement he said, “My uncle’s bought it and I hear Mr. X is also buying…” Ordinarily, this could be a good thing as experienced investors are usually a good source of information (though you need to do your own investigation).
However, when I asked if he had probed them on why they purchased the stocks he said, “I don’t care, if it is good for them it is good for me too”. Really?!
This is called “herding”. Just because someone “regarded highly” buys a stock, other people may see it as a good investment and just dive in. No analysis. No questions. Not even, what makes this a good investment? The truth is, herding has been observed to happen even with experienced financial professionals (I mean no disrespect) so if you do this, don’t worry, you are not alone. However, just to be clear, a good investor would carry out his/ her own assessment – just in case.
There are a few problems with this behaviour that include spending money on stock you don’t need or buying an overvalued company’s shares (at the wrong time I might add). Any of these can potentially lead to loss of money, financial strain and all-round sorrow. I have been there too, several times actually. Now, when I read of the latest “hot stock”, my first action is to carry out stock analysis before anything else!
Solutions? Well in my opinion, there 3 ways we can control our herding behaviour:
Finally in my opinion, there is no short cut to stock market success.
Till the next post…