A ‘Candid Camera’ Perspective in Social Conformity & Herding Behaviour in the Markets.

I love this amusing clip from the classic 1960’s TV show ‘Candid Camera’. It beautifully captures the way humans conform to the behaviour of the crowd.

Conformity - elevator candid camera from Prof. Keenan on Vimeo.

Whilst it might be a bit if fun, and almost certainly heavily edited, it does nicely emphasise the way humans conform to the behaviour of the crowd. There are many reasons for this, and I think it’s helpful to understand these when we try to understand markets and market behaviour.

No matter how much we know, or we think we know, the truth is we are limited: We cannot know everything and we have limits to how much information we can process. Therefore as a species we have learned to pool our knowledge and to rely on the knowledge of others. As a result we are prone to thinking in this way, and sometimes, even if you are convinced that a particular idea or course or action is incorrect, you might still find yourself following the herd, believing that they know something that you don't. This is exaggerated in situations in where an individual has little experience. I like to refer to the writing of Jon Maynard Keynes at this point, he once compared the way investors pick stocks to how participants would be successful in winning a type of newspaper beauty-picking contest common in the 1930s:

‘It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.’

What he describes, is one of the reason why markets display herding behaviour; people make conscious efforts to pick those stock that one believes other people are likely to pick. Personally I can’t think of a better reason to buy a stock than the belief that everyone else will be buying it. Nonetheless, I believe this is a good example of acquiescing to one’s belief in the knowledge of others. This is what everyone who trades is trying to do, whether their tool for picking is fundamental assessment of value, quantitative measures of expectations of value, or attempts to identify patterns in price action as a predictive tool.

A further strong reason for herding behaviour, which has its roots in our subconscious, is the fact that
we are hard-wired to confirm to the behaviours of the crowd. We evolved to be this way: Early humans learned to cooperate, share and to be mutually dependent on each other, this almost certainly greatly increased their chances of survival. Those ‘conforming individuals’ were far more likely to pass on their DNA, through the millennia, than those who failed to conform. Those who preferred not to confirm were more likely to have been rejected by social groups, and thus left to fend for themselves. Though I would stress, that this does not preclude competing, which is also part of the human condition. Nonetheless, as much as we like to think of ourselves as individuals, the fact is that we're driven to fit in, and that usually means going with the flow. As stressed somewhat humorously by the candid camera clip.

Successful trading and investing requires understanding not just the behaviour of the crowd (the market), but also a degree of knowledge of why they act in certain ways, as well as how that affects you and your decision-making. This does not mean one should not stand against the crowd when trading and investing, however this makes the timing of trades and investments all the more important. Anyone (and there were many) who had a very good reason in their mind to short the stock market in recent years will be all the more conscious of that fact.

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