In market terms, herding occurs when market participants react to information about the behavior of other market agents or participants rather than to market action or market fundamentals. The quintessential example is probably the dotcom boom around the turn of the century (Pets.com!). It may be the most prevalent of our biases. Charles Mackay’s famous 1841 classic on financial herding, Extraordinary Popular Delusions, is a must-read for every would-be financial analyst, trader or money manager.
In simpler terms, we all tend to follow the crowd, sometimes for good and sometimes for ill (think of the lemming suicide myth). We do so out of social conformity (think of high school) and out of fear (being wrong in a large group often doesn’t matter much but being wrong alone can be career suicide).
We all run in herds of varying sorts, of course — large or small, bullish or bearish. Institutions herd even more than individuals in that investments chosen by one institution predict the investment choices of other institutions to a remarkable degree. Even hedge funds seem to buy and sell the same stocks, at the same time, and track each other’s investment strategies. That affinity fraud (e.g., Bernie Madoff predominantly fleeced the Jewish community to which he belonged) is so common is definitive evidence of herding.
Below is visual evidence of herding in the wild — sheep-herding filmed by drone — and it is mesmerizing. In the investment world, it is not nearly so beautiful.