Herd Instinct
What it is:
A herd instinct is emotional pressure to agree with other members of a group. The herd instinct results in failures to think critically about an issue, situation or decision.
How it works/Example:
Let's say John, Jane and Jeff are fund managers for the XYZ mutual fund company. They meet weekly to discuss their investing strategies and their top picks. The three get along well and trust each other's judgment.
One day, Jeff proposes buying shares of ABC Company for his fund. He plans to make a large buy and says he likes the company's fundamentals. John and Jane go along with the plan and buy the stock for their funds, too. Two weeks later, the stock has fallen by 50%.
John, Jane and Jeff are the victims of the herd instinct. They didn't independently analyze the stock and instead relied on everyone else in the group to point out flaws in Jeff's thinking.
Why it matters:
In the investing world, groupthink is akin to herd instinct. Knowing how to recognize the herd instinct provides a tremendous opportunity for contrarians to recognize when investors are buying or selling without thinking. This allows contrarians to question trends and even go in the opposite direction.