Have you ever noticed in a crowded movie theatre, a single person leaving triggers a mass exodus? This is the herding effect in action, and it doesn’t just happen at the cinema – it can also gallop through the Indian stock market.

The stock market is a dynamic and often unpredictable environment. Investor behavior plays a surprisingly large role in determining market trends and asset prices.  One critical behavioral phenomenon that shapes the Indian stock market is known as the “herding effect”.

What is the Herding Effect?

The herding effect refers to the tendency of investors to follow the actions of others, often disregarding their own analysis or information. This behavior can be driven by various factors, including:

• Fear of Missing Out (FOMO): Investors often fear the regret of missing out on potential profits if others are heavily buying a particular stock.
• Information Cascades: Sometimes, investors simply mimic the choices of larger groups under the assumption that the larger group must have made well-informed decisions.
• Limited financial literacy: Individuals with less knowledge and experience in the market may be more susceptible to herding, relying on others’ decisions rather than conducting their own research and analysis.
• Seeding the herd: Influencers with large followings can act as the initial trigger for herding by endorsing specific investments or promoting certain financial trends.

How Does the Herding Effect Manifest in the Indian Stock Market?

The herding effect can lead to several observable effects in the Indian stock market:

• Exaggerated Market Movements: Herding can amplify market movements. When a group of investors collectively jump on a trend, it can accelerate price increases or declines beyond what fundamentals would suggest.
• Market Bubbles and Crashes: Herding can contribute to the formation of asset bubbles where prices become artificially inflated purely due to investor enthusiasm and FOMO. These bubbles eventually burst, leading to sharp market crashes.
• Reduced Market Efficiency: The herding phenomenon undermines market efficiency as prices might not accurately reflect the underlying value of stocks if they are largely driven by crowd behavior.

The herding effect can have a substantial impact on stock prices. Positive news or a sudden surge in demand for a particular stock can trigger a domino effect, causing more investors to buy in, thereby driving the price even higher. Conversely, negative sentiments can result in a mass sell-off, intensifying market downturns.

 Examples of Herding on specific stocks and Industries: –

1. Technology Stock Frenzy (2017-2018):

During this period, the Indian stock market witnessed a herding effect in technology stocks. Fueled by global tech trends and a surge in demand for digital services, investors flocked to technology companies. The herding behavior led to inflated valuations and a subsequent correction, impacting both established players and emerging startups in the sector.

2. Real Estate Boom and Bust (2005-2008):

The real estate sector experienced a herding effect as investors, enticed by the housing boom, poured funds into real estate stocks and projects. The collective optimism resulted in a price bubble, but when the market sentiment reversed, the herding effect intensified the downturn, causing significant losses for investors and affecting the broader economy.

3. Pharma Sector Rollercoaster (2016-2017):

The pharmaceutical industry in India faced a herding impact during this period. Positive regulatory developments and increasing global demand initially attracted investors. However, when regulatory challenges surfaced and market sentiment shifted, a herd-driven sell-off ensued, affecting even fundamentally strong pharmaceutical companies.

4. Renewable Energy Hype (2019-2020):

Renewable energy stocks experienced a surge in interest driven by global sustainability trends. The herding effect led to overvaluation of many renewable energy companies. When external factors like policy changes and economic conditions shifted, the herding behavior intensified the market correction, impacting investors who had blindly followed the renewable energy trend.

5. Banking Sector Stress (2018-2019):

The banking sector witnessed a herding impact during a period of increased non-performing assets (NPAs) and regulatory scrutiny. As negative sentiment spread, investors collectively sold off banking stocks, intensifying the downward spiral. The herding effect contributed to exaggerated market movements, affecting the stability of the banking industry.

These case studies illustrate how the herding effect can significantly impact specific stocks and industries in the Indian stock market, emphasizing the importance of investor awareness, diversified decision-making, and a nuanced understanding of market dynamics.

Sometimes, the herd might be heading in the right direction, especially when reacting to genuine positive developments. However, relying solely on herding behavior is a risky strategy.

Taming the Herd Instinct

So, how can you avoid being swept away by the herd mentality in the Indian stock market? Here are some tips:

• Do Your Own Research: Don’t just follow the crowd. Analyze companies, understand their financials, and assess their future prospects before investing.
• Maintain a Long-Term Perspective: Short-term market fluctuations shouldn’t dictate your decisions. Focus on your investment goals and build a diversified portfolio for the long term.
• Beware of FOMO: Don’t let the fear of missing out cloud your judgment. Stick to your investment plan and avoid impulsive decisions based on market hype.

So, Stock market is a complex ecosystem, and sometimes, it can feel like a raging river. Individual investors can get caught up in the “herding effect,” where they blindly follow the crowd, chasing hot stocks or panicking during downturns. However, there’s a life raft in these turbulent waters-Mutual funds. By offering diversification and professional management, mutual funds can help investors navigate the choppy waters of the herding effect and potentially achieve better returns.

Below is the list of some mutual fund schemes along with their returns.

By understanding the herding effect and adopting a disciplined approach, you can navigate the Indian stock market with more confidence and potentially achieve your financial goals. Remember, successful investing requires a clear head, not just following the herd mentality.

To understand more on the topic as well as to start investments please feel free to contact us:

Phone: +91-9324609115

E-mail: team@richvikwealth.in

The article is authored by Mr. Mayur Solanki from Team RichVik.