You will have probably seen it addressed before, as no matter the form of trading or investing, herd behaviour has a tendency to run rampant. By definition, herd behaviour is the act of following, mimicking, and relying upon the actions of a large group, instead of relying upon one’s own individual initiative. In the realm of forex trading, herd behaviour can be seen occurring almost every single day, to the point where you will even see some of the most experienced traders around “follow the crowd” at times.
There will be times in which following the herd could be considered a wise move, but over the long term, it can prove to have harmful effects on anyone’s trading efforts. The following explains herd mentality in further detail and lays out why it may just be the biggest danger in forex trading.
Counteracts Growth as a Trader
The life of a forex trader is one that is centred on progression. Over time, your skills, habits, and—subsequently—the quality of your portfolio should all improve. When you sink into herd mentality, this progress can be harmed. What herd mentality can be tied into is an underlying fear, a fear that is linked to going against the grain and making the wrong decision. For this reason, novice traders are most likely to be susceptible to the herd mentality.
The reality of the matter is that by choosing to follow the herd, it won’t just stall trader growth, but it can actually damage it. It means that you will be less likely to analyse the characteristics associated with a trade, as you are essentially backing the thoughts and opinions of others blindly. When it comes down to it, herd mentality will counteract your growth as a trader.
Has the Power to Lead You Astray
Trading forex can often be a complicated affair, as what’s pulling the price of currency up and down can change in a flash. What herd behaviour tends to do is overly simplify the act of trading, something that can have disastrous effects. Nullifying your opinion, herd behaviour can lead any trader astray, as opinion and herd movement can switch between optimism and pessimism on next to nothing, sometimes turning you away from what might be the right path.
When you take it upon yourself to form your own opinions in the world of forex trading, what you are doing tends to carry additional weight. Herd mentality means that you are going to follow a crowd that can be fickle and temperamental, and thus you could very well be led astray and possibly away from what would otherwise be an effective trading strategy.
Diminishes Trading Edge
Anyone who subscribes to herd behaviour will be thinking that “everyone can’t be wrong”, but that can be a very misleading thought process. Following a crowd of investors can reduce your trading edge, as herd behaviour takes individualism almost entirely out of the equation. Everyone’s portfolio is different, having been built through different currencies and currency pairs. To make better trades, you need to have a firm understanding of what works for your particular set of trading circumstances. You also need to be willing to stand apart and stand alone if necessary, even if this means making moves that don’t quite fit in with what others are doing.
When you choose to follow the herd, you are diminishing your trading edge, a trading edge that could prove to be vital in maintaining a profitable and healthy forex portfolio.
Is a Lagging Indicator
While sometimes the herd can be right, there is a high risk you find out about it too late. Following the herd puts you at serious risk of trading the movement after it has occurred. The smart money traded their own ideas and then the dumb money follows only too late getting in at the tops and bottoms after the original reason for entering the trade has passed.
Can Easily Cloud Judgement
Forex is a fast-paced and ever-changing form of investment, as no two days are quite the same. This means that personal judgement on what is right and what is wrong is a key tool in the arsenal of any forex trader. Herd behaviour carries a certain draw to it, as you may tell yourself that so many people can’t be wrong. However, that sums up the trappings of herd mentality, as herd mentality, without a doubt, can cloud your judgement. When faced with a mass movement of traders, remember that it’s not about what they’re doing; it’s about your judgement of the current situation.
The temptation to follow the crowd within the world of forex will certainly be strong, but you must understand that doing so can often have a negative impact on your portfolio. Traders who achieve high-grade profits think independently, as they sidestep herd behaviour and its dangers and are willing to stand alone, reaping the benefits as a result.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.