When I read Andre Kostolany’s book “The fabulous World of money and the stock market”, I remember how he never stopped mentioning how important it was to bet against crowd behaviour and how one very good book about this matter was “Psychology of the masses” of Gustave Le Bon, which I also read. A book that despite the years has not lost its actuality. Although those who have a socialistic or communistic view of things will not enjoy too much that read. We already know that socialists are defenders of “masses” so to speak.
This matter of masses is, as everything that surrounds trading and investing, extremely subjective.
As every social science, marked by praxeology laws, we do not have clear statistic laws, but we have to conform to the terrain of “speculation” and uncertainty.
Basically mass behaviour occurs at the two ends of the investing world: short-term trading and long-term investing.
Masses are searching for long-term profits but most of them try to do so by trading the short-term time frames of the markets.
Crowd Behaviour in markets
What most people do is what they are sold the most: recommendation to “invest” doing all the short-term trading markets, like binary options, futures, Forex, CFDs, etcetera.
In other words, they act guided by what the collective behaviour tells them.
Not many can escape to this sort of crowd madness and start investing in the long-term when they are in their twenties.
No, most people will try to dominate the small time frames of the market looking for easy money.
It is the “easy money” in adverts everywhere that attracts all these people eager to become rich as soon as possible.
Crowd behaviour analysis
Masses or crowds normally buy when the markets are trading at their peaks and selling when the markets are trading at their lows.
In this process, the “strong hands” and those who maintain a strategy of buy and hold are successful but they are not the majority.
In the first place, we have to have clear that the crowd do not invest in the stock market. In other words, the majority of the population do not participate in the game of stock investing, the one with better returns the last 200 years.
This, by itself, tells us that crowd behaviour is quite mistaken.
Let us say that the majority of people prefer to invest in other ways, like deposits or houses. But also we should not forget that those who save are not many and in reality the majority of the population do not save up money.
That is why the simple fact of participating in the stock market means that we are already out most of the crowd.
The matter, obviously, do not end there.
As I said before, the majority who start in the world of investing and especially those who are young, will do so after being attracted by some advertisement the sort of those that promise great returns in a short time.
Things like: “making a living from home trading two hours a day” and alike are quite common.
In these first trading lessons of every person, long-term quiet investments are not very attractive since they cannot compete with adverts that promise 20% profits a month or “95% of winning trades”.
When the novice investors see those adverts go in “masse” where they think they have better chances to win.
The problem is that those possibilities are the fruit of lies, in most cases.
Some, the minority, will be able to see a small light of the truth and will start trading for the long-term and investing.
Those who survive the short-term trading frenzy will end up doing some sort of “buy and hold” strategy.
However, do not think that those are a majority of people.
In reality the average household in the world do not have investments in the stock market.
Many of the men who save see the stock market as something evil, something they do not understand really.
In this sense I remember one personal case: that of my father long time ago.
He had a nice deposit in a Spanish bank.
The director, seeing that money and the chance to get some commission told my father that it was good idea to buy stocks of the bank.
My father accepted to put some money in the bank stocks, especially after hearing how good those stocks were by the bank manager. My father trusted the guy with the suit obviously.
My father had no idea about the stock markets.
Well, shortly after he bought those 500,000 or 1,000,000 pesetas (the Spanish currency of the time) the stock fell strongly and when he saw that he was losing something like 20 or 30% he sold the stocks.
After that he never wanted to know again of the stock market.
This is a perfect example of crowd behaviour in the stock markets.
Countless savers were “recommended” to buy those bank stocks by countless manangers at that time.
As I said, the majority of people do not invest or trade in the Stock market, but many of them will do some day after some recommendation by some “expert”, in this case bank staff.
The reasons will be the typical: “you have to buy because the market is rising”.
The problem is that this type of recommendations usually comes before a correction.
When the people buy and see how their stocks start falling they sell in panic mode.
The thing is that there will always be more people falling in this kind of trap.
There is never a shortage of “experts” either.
You can find this kind of behaviour in different kind of forms.
A lot of people usually get interested in something, like Nasdaq 1999, when the market is about to explode.
When the entire crowd has come to make “business” it means that the business is over, which is quite logical since when everybody open the same kind of shop, they stop doing well.
The same happens in the stock markets.
When the crowds invest it is usually quite late.
Crowds and short-term trading
With respect to short-term trading and its specialities like: scalping and binary options there are other issues.
Here, the prominent fact is the search for easy money.
Everybody is looking for the best gurus or traders who can give them the key to success.
Those kinds of traders are the ones who offer better returns, at least in their “adverts”.
Many of the “successful” short-term traders do well by cutting their profits short and letting their losses run.
This work for the short-term when some accounts can boast great returns and lure a lot of crowds into buying their systems or signals.
The problem is that this kind of system is “destined” to lose eventually in a catastrophic way, wiping out all its followers with it.
For example, if you want to have success attracting people in a marketing campaign it is better to promote 100% profit in two months than 10% in one year.
The system with 50% profit a month will attract a lot of flies.
The problem is that the system that won 50% every two weeks for several months will lose 100% in a few days
Collective crowd behaviour
In general there will be just a few capable of beating the mental barriers and dedicate their efforts to the long-term trading.
Many of those who start with the short-term trading frenzy will abandon after a while hopeless.
The rest will end up joining the long-term investing strategies, but they will be just a minority.