The Wisdom of The Crowds is defined by Investopedia as “the idea that large groups of people are collectively smarter than individual experts when it comes to problem solving, decision making, innovating and predicting.” In other words, it is very difficult for any single investor, even an expert, to be wiser than the wisdom of the crowds. It would require the average investor to outguess the collective wisdom of all other investors in the market, and this is truly a Herculean task.
Adopting a herd behaviour
“The term herd instinct refers to a phenomenon where people join groups and follow the actions of others under the assumption that others already did their research. Herd instincts are common in all aspects of society, but particularly within the financial sector. Investors tend to follow what they perceive other investors are doing, rather than relying on their own analysis.” – Investopedia
Understanding investor psychology
Clearly it is important to understand investor psychology. It can be broken into 2 parts:
- Investor Sentiment: Which measures what investors are saying, writing in their research reports and how they’re reacting to news etc.
- Investor Behaviour: Which measures what investors are actually doing. Measuring fund flows is a window into understanding investor behaviour. Inflows may suggest that investors are optimistic about potential future returns while outflows suggest that investors are wary.
The pitfalls of following the herd
Research has suggested that investors can many times be wrong, particularly at the extremes. The Wisdom of The Crowds turns into crowd mania, which often leads to sharp reversals leading to losses.
Using price momentum to ascertain market behavior
Price momentum: Price measures the current “psychology” of the “herd” and is the clearest representation of the behavioural dynamics of the living organism we call “the market.” Technical indicators and signals are useful in identifying changing market trends and their strength. They are useful in reversals, measuring conditions of overbought or oversold and in general, to keep a check as you follow the crowds.
How Augment’s bringing it all together
At Augment, we use financial data and analysis to capture each of the three perspectives, investor sentiment, investor behavior, and price momentum, to help you identify where investors are currently leaning and how they’re voting with their money.
We provide analysis that will help you make well-informed investment decisions and help you invest with confidence.