A Birds-Eye View Of Market "Herd Mentality"

Tyler Durden's picture

Submitted by Lance Roberts of STA Wealth Management,

The market is a giant living organism of human behavior and trying to predict what the market will do in two weeks, much less twelve months from now, is pure folly.

However, by looking at the price trends, and using some statistical analysis, we can garner a view of the direction that the “herd” is most likely heading.

There is a fascinating analogy in nature, called murmuration, that very much resembles the “herd mentality” in the markets.

Starlings, which gather in the evenings to roost, will often participate in what is called a murmuration — a huge flock that shape-shifts in the sky as if it were one swirling liquid mass.

This behavior is often sparked by the presence of a predator, like a hawk, and the movement is based on evasive maneuvers. There is safety in numbers, so the individual starlings do not scatter, but rather are able to move as an intelligent cloud, feinting away from a diving raptor, thousands of birds changing direction almost simultaneously.

The question that has had scientists stumped is how a bird, tens or hundreds of birds away from those nearest danger, sense the shift and move in unison?

The secret lies in the same systems that apply to anything on the cusp of a shift, like snow before an avalanche, where the velocity of one bird affects the velocity of the rest. It is called "scale-free correlation" and every shift of the murmuration is called a critical transition.

Giorgio Parisi, a theoretical physicist with the University of Rome, wrote:

"The change in the behavioral state of one animal affects and is affected by that of all other animals in the group, no matter how large the group is. Scale-free correlations provide each animal with an effective perception range much larger than the direct inter-individual interaction range, thus enhancing global response to perturbations."

This is critically important to understand when it comes to investing as the markets, much like a flock of starlings, are an interconnected web of individuals all reacting simultaneously to the same set of inputs. When the "velocity" of a small portion of the “herd” changes, the velocity of the rest of the “herd” is changed as well. The idea of a “scale-free correlation” is a critical dynamic in market movements.

Stockcharts.com has a unique tool call a "relative rotation graph" which they describe as:

"RRG™ charts show you the relative strength and momentum for a group of stocks. Stocks with strong relative strength and momentum appear in the green Leading quadrant. As relative momentum fades, they typically move into the yellow Weakening quadrant. If relative strength then fades, they move into the red Lagging quadrant. Finally, when momentum starts to pick up again, they shift into the blue Improving quadrant."

If you watch the video above of the movement of starlings during murmuration, the animated video below of major market indicies over the last year shows a very similar effect. (Indicies shown: S&P 500, S&P 600, S&P 400, Emerging Markets, International, Nasdaq, DJIA, and NYSE Energy)

 (Note: Since energy has been a major headline event I added the NYSE Energy index just for comparative purposes. As you will notice, the energy sector remains highly correlated with the rest of the "flock" until just recently.)

The crucial point is that in the financial markets the herd dictates the general price trend of the markets. Like the flock of starlings, stock market investors become extremely complacent in the financial markets until an exogenous event becomes an identifiable threat and changes the "velocity" of market participants which then ripples through the entire financial organism.

This is why the majority of investors, as shown repeatedly by investor studies such as Dalbar, underperform over time because of investing mistakes associated primarily with "herding mentality." To wit:

"While the inability to participate in the financial markets is certainly a major issue, the biggest reason for underperformance by investors who do participate in the financial markets over time is psychology.

Behavioral biases that lead to poor investment decision making is the single largest contributor to underperformance over time. Dalbar defined nine of the irrational investment behaviors:

  • Loss Aversion – The fear of loss leads to a withdrawal of capital at the worst possible time.  Also known as "panic selling."
  • Narrow Framing – Making decisions about on part of the portfolio without considering the effects on the total.
  • Anchoring – The process of remaining focused on what happened previously and not adapting to a changing market.
  • Mental Accounting – Separating performance of investments mentally to justify success and failure.
  • Lack of Diversification – Believing a portfolio is diversified when in fact it is a highly correlated pool of assets.
  • Herding– Following what everyone else is doing. Leads to "buy high/sell low."
  • Regret – Not performing a necessary action due to the regret of a previous failure.
  • Media Response – The media has a bias to optimism to sell products from advertisers and attract view/readership.
  • Optimism – Overly optimistic assumptions tend to lead to rather dramatic reversions when met with reality.

The biggest of these problems for individuals is the 'herding effect' and 'loss aversion.'"

These two primary behaviors tend to function together compounding the issues of investor mistakes over time. As markets are rising, individuals are lead to believe that the current price trend will continue to last for an indefinite period. The longer the rising trend last, the more ingrained the belief becomes until the last of "holdouts" finally "buys in" as the financial markets evolve into a "euphoric state."

As the markets decline, there is a slow realization that "this decline" is something more than a "buy the dip" opportunity.  As losses mount, the anxiety of loss begins to mount until individuals seek to "avert further loss" by selling. As shown in the chart below, this behavioral trend runs counter-intuitive to the "buy low/sell high" investment rule.


In the end, we are just human. Despite the best of our intentions, it is nearly impossible for an individual to be devoid of the emotional biases that inevitably lead to poor investment decision-making over time. This is why all great investors have strict investment disciplines that they follow to reduce the impact of human emotions.

More importantly, despite repeated studies and mainstream commentary that show "buy and hold," and "passive indexing" strategies do indeed work over very long periods of time; the reality is that few will ever survive the downturns in order to reap the benefits. Most investors, like the starlings that are late in making the turn, eventually become "dinner" for the market's predators.

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HedgeAccordingly's picture

Stawk herding. Giddy up ride em cowboys.

KnuckleDragger-X's picture

I used to do work for various ranchers and cattle are easy to herd unless they are startled and start to panic, if that happens you don't want to be in front of the stampede.

daveO's picture

Still more realistic than that efficient market thingy.


buzzsaw99's picture

as the chart shows it always goes up in the long run

venturen's picture

except the countries and companies that disappear. How is that Japanese thing working for you? How is that Panam Stock working for you?

Dr. Engali's picture

Things are so fucked up in this country that they will probably win.

sleigher's picture

Can we get a list of the family names?  I want to see if their mortgages were paid off too...

Old Poor Richard's picture

That would be the achetype for irony, that crisis actor "parents" win damages.  One of their arguments is that the AR-15 was designed to penetrate helmets.  The fictional victims were wearing fictional army helmets, hence fictional liability.

kchrisc's picture

Like the "magic bullet theory," it is only "madness" if one believes it.

No one died at Sandy Hoax, so the AR-15 suit is more Zionist intrigue to get our weapons.

An American, not US subject.


"When taking prisoners, the first demand is always for the enemy to surrender their weapons."

daveO's picture

The timing was right before Christmas after the mid-term elections, in which they were 'shellacked'. Same as now. What kind of bomb will they put under the Goy's tree this year?

Pickleton's picture

If I'm not mistaken this has been tried and failed.


I have a question tho.  If these idiots end up successful and the manufacturer of a tool can be made liable for it's use, then cannot they also be held responsible for it's correct use?  In other words, what's to stop ANY manufacturer from demanding you pay them royalties on what you make from their tool's use...?

Sub MOA's picture

I think you answered your own question... new "copyright" laws ...remember that fool saying "you didn't build that"   well that bird house ya made with that drill press and table saw was intellectual property of the drill and saw makers now you owe them part of the profit.  small ex but I can see these fucking weasels trying it only a matter of time

kchrisc's picture

Victims and/or their families of Drone bombings at various schools and wedding parties around the world should now sue the manufactures of the Drones. And the missile manufactures as well.

See how far that gets in the Zionist "Just-Us" system.

An American, not US subject.


"We came, we saw a school, we conquered the school."

medium giraffe's picture

giant ball of stupid. gotcha.

Greenspazm's picture

More words.
Just googled "STA wealth management performance" and came up with zilch. No AUM it seems.

Downtoolong's picture

Cool, now show us what happens then the center of the flock flies into the power lines.


ThisIsBob's picture

Or gets hit with a few rounds of birdshot.

Liquid Courage's picture

Nothing. Not grounded, no circuit path, therefore no current flows.

Dr. Engali's picture

So who wants to be short just before old Yeller speaks? Any takers?

YHC-FTSE's picture

"The market is a giant living organism of human behavior"

You're about half a decade behind the times, bub. Er, what investor? I thought retail went out of the markets ages ago - hence the almost daily low volume ramps. It was fun quoting behavioural science 6 yrs ago when there were some carbon based lifeforms in equities, but surely we're not doing this again are we?

Herd is not the collective noun for this phenomena. More like a menagerie of banks and their algos.

Liquid Courage's picture

Perhaps instead of prey reacting to a predator, it's more like the opposite: a pack of hounds chasing a single fox. Still an over-simplification, though what, with all the networking going on.

Pareto's picture

+100 fucking brilliant YHC

venturen's picture

why am I still at depression? And where the heck is pessimism? 

noben's picture
noben (not verified) Dec 15, 2014 2:30 PM

This chart also works and is rather funny gallows humor, if you apply it to the Doomsday Cycle and its adherents.

Just having some fun. ;-)

falak pema's picture

If the market is the "herd" mentality then rationality and supply and demand EQUILIBRIUM, aka invisible hand, is a pipe dream. 

In a herd mentality construct its obvious to anybody with an iota of sense that the Oligarch will RUN the herd as he also runs the market.  he is the bison killer with his Winchester 73 rapid fire mechanism; aka HFT and dark pools. 

Thank you very much. The Hayek and Mises of this world can go change their underwear. 

Hubbs's picture

So what is wrong with the fish (sardines) shoals analogy?

chistletoe's picture

are you reading my material?  sheesh .....


Well, at least, imitation is the highest form of flattery .... I am honored ....

nuubee's picture

This is critically important to understand when it comes to investing as the markets, much like a flock of starlings, are an interconnected web of individuals all reacting simultaneously to the same set of inputs.

Ah... Don't you mean to say... "the markets are an inner circle of a few well-financed and TBTF bankers."

If we had actual free markets, the rest of the argument makes sense. Since we don't, it's diminished

joego1's picture

More like a cockroach scatter-gram.

kevinearick's picture

I am engaging the machine now.

The third party flags have two elements, venue shopping to maximize nesting at origination, home field advantage, and SCOTUS shorting itself out by enforcing resulting growth in the Fourth Branch of Fascists, with Homeland Security, criminal prosecution with no due process, decades before 9/11. Monetary and fiscal policy have simply been backfilling the growing income gap with inflation / lost purchasing power, social loss under the line for you and corporate profit above the line for the fascists, law enforcement by i-phone credit checks these days.

Funny, how little football has to do with outcomes in the NFL real estate game, which anchors the media empire. SCOTUS has been making chicken soup out of chicken sh- for so long now that the population is normalized to the process of corruption, and it’s just a bit in a computer upon which the weight of the inverted pyramid rests. I was jumping on tractors and running wire since I was five, so public education was always nonsense to me.

Everything after jurisdiction is a symptom. Don’t walk into that casino expecting anything else. The wizard is the one running in front of the parade.

Wild Theories's picture

I just love the starling video

nice to know it's called murmuration, always being aware of the effect, now I know the official name for it


random question: is the group behaviour thing the reason some humans engage in orgies?

Boubou's picture

The problem I see is that the results of these herd movements have real consequences on the companies and systems involved, which can result in real actions by the boards and regulators.

So the asset you are clinging to because it's downfall results from murmuration, and is without reason  concrete causes,  may still take damaging steps or fail anyway.

So I can't think of a practical strategy to make use of this insight, except to stay out of the casino.