The Consequence of Herd Behavior in Forex

Winsor Hoang |

Simply put, herd behavior is the tendency for an individual to mimic and rely on the actions and beliefs of a large group instead of acting on their own individual views. This has been seen countless times in the financial industry. A common example would be the bursting of the internet bubble in which the dotcom herd sunk large amounts of investment capital into internet related business, even though most of these business would have been considered uncertain ventures. Why would otherwise educated, skilled investors risk so much money on unsound businesses? Well, everyone else was doing it. It is this mentality that drives herd behavior in Forex. While many traders fall into herd behavior, some cannot understand why it should be avoided if you are striving to be a consistently profitable trader. Thus in order to become diligent in preventing herd behavior, one must realize just why it's so consequential for traders.

1. Stifles Individual Growth as a Trader

The underlying emotion behind herd behavior is fear; a trader will fear that their contrary position will affect their reputation as a competent decision maker. Trading is a “lonely” activity, but a vast number of people dislike being alone in their decision. They prefer to have it confirmed and assured by others so as to prevent looking like a lone fool. Novice traders are most vulnerable to herd behavior. They have not built their skills to a level where they feel confident in their own judgements as trader. However, following the crowd is just about the worst way to develop one's trading skills. It prevents a trader from seriously taking a look at their individual strengths and weakness. This makes them less likely to analyze what characteristics they need to hone, and which skills they can immediately utilize for creating consistent profits. Herd mentality stifles individual growth and traders who do not grow in the field of Forex struggle to make profits.

2. Leads You Astray

If every trader could recognize the equilibrium value of a currency, there would be no room for excess volatility in the market. However, because fundamentals are too uncertain the trader's life is quite challenging. Thus herd behavior is applied as a means to rationalize and simplify trading. And with this comes a trader's change of opinion as they opt for group mentality rather than their own. As a result they may make a decision that they otherwise wouldn't have had they relied on themselves. This change of opinion has led many traders astray. As traders go from optimism to pessimism and visa versa about a market trend, traders are now making trades based on intuition rather than evaluation and analysis of the fundamentals. Had they taken the time to truly consider their decision, they may have been able to avoid the costly consequences that are so often seen in investment herd behavior. Because they are relying on the certainty of the opinions of those around them, rather than testing and analysing the certainty of the information, they are more likely to be led astray.

3. Doesn't Give You an Edge

The driving force behind herd behavior is “everyone can't be wrong.” But in Forex, if everyone is doing it, chances are it no longer has an edge. An edge, for a trader, is their weapon. It's also the difference between simply making trades and making consistent profitable trades. Because herd behavior replaces individualism with group think, a trader is less likely to look for ways to stand apart from the crowd. However, unless they separate from herd behavior, they won't know what personal strengths they can use to make better trades or how to effectively apply them. Forex is an individuals sport. It's for those that like to stand apart and be lone rangers. A trader who is highly dependent on the opinions of others and simply mimics others will deprive themselves of building an edge. This in turn prevents them from making consistent profits.

While you may be tempted to follow the crowd, it's important that you realize how consequential it can be to your Forex business. Traders who are profitable do not fall into herd behavior. They have the courage to stand alone.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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