The Perils of Following the Flock: Understanding Sheep Mentality

Sheep Mentality

Sheep Mentality in Trading and Investing

Updated Dec 2022

Traders that are driven by fear lose on both ends of the trade; they don’t short the markets or go long. Shorting the markets is not a recommended course of action when the trend is positive. However, at least one is attempting to do something instead of letting fear take over. After that harrowing experience, they have nothing to show for it, other than an even larger appetite to be taken to the cleaners at some future date. This is sometimes referred to as the secret desire to lose syndrome. Market Update Sept 9, 2020

Before we continue, remember the expression or sayings such as misery loves company and or the Tactical Investor’s variation that adds a second part, and stupidity simply demands it. Or another two TI saying Riches come to those who seek it, or the early bird gets the worm and the late one the bullet. No matter how hard one tries, one cannot change the order.

The deeply ingrained sheep mentality that characterizes the masses has long been a losing strategy. The stark reality remains inexplicably elusive to many: fear is a pauper’s reward. Therefore, the history of the markets serves as a warning that those who fail to heed the lessons of the past are destined to replicate their failures with astonishing precision. Only through the steadfast application of a contrarian and tenacious mindset can one hope to navigate the treacherous waters of the financial world with any degree of success.

The Dangers of Groupthink in Trading and Investing

Peter Lynch, a Wall Street legend, is renowned for having generated annualized returns of 29% between 1977 and 1990, a feat that helped propel Fidelity’s Magellan assets past the $14 billion mark. One would naturally assume that those who invested in his fund would have reaped similar rewards. But alas, the human propensity to self-sabotage, the so-called “secret desire to lose syndrome,” prevailed, and most of the investors in the fund lost money.

How could this be? It is simple, really, fear pays poorly. The masses are wired to panic and flee at the first sign of danger, stampeding towards the hills like a herd of frightened animals. This explains why so many of our new Tactical Investor subscribers panicked when the markets sold off in March, while the more seasoned investors who had read our suggested materials and past market updates embraced the pullback and reaped significant rewards. Though both groups subscribed, their outcomes were vastly different. In investing, the ability to remain calm and rational, even in the face of adversity, separates the wheat from the chaff.

The Dark Side of Conformity: Risks of Sheep Mentality

In the same vein, the primary reason that so many Magellan fund subscribers lost money was that they tried to outdo Peter Lynch himself. They bought into the fund when it was performing well and sold when things looked dire, a perfect recipe for financial ruin. It is for this reason that we view performance statistics as meaningless. A much better approach is to scrutinize past material and draw your conclusions because even when one person walks away with 100% in gains, the other could technically lose everything.

Returning to Peter Lynch, the truth is that most investors jumped into the fund when it was doing well and sold when it was performing poorly. Instead of buying low and selling high, they made the cardinal mistake of buying high and selling at the bottom. Fidelity conducted a comprehensive study, and the results were truly eye-opening. Not only did the average investor fare poorly, but they failed even to break even. It is almost unimaginable that a fund with such outstanding returns could have failed to reward its investors. The only reason that comes to mind is sheep mentality—following the losers to the end of the slope. In other words, they were doing what they were not supposed to do at precisely the right time.

What is the lesson here?

The simple truth is that, no matter how talented the fund managers may be, irrationality invariably trumps logic. Investors let their emotions govern their decisions, buying based on greed and selling based on fear. The net result is that such a strategy offers virtually no chance of success.

As we anticipate the market soaring to unprecedented heights, it is worth remembering that most investors will find it challenging to generate meaningful returns, for they will follow the same tired playbook. This means that the savvy Tactical Investors who read our past market updates and other materials will have the opportunity to make out like bandits.

Bearish sentiment rose slightly, note that this data was collected before the markets started to sell off. Remarkably Bullish sentiment is now trading below its historical average for over 30 weeks in a row. While bearish sentiment refuses to drop below 33.00. All in all, this means that no matter what the expert’s state, every healthy pullback ranging from mild to wild has to be embraced without exception. Market Update Sept 9, 2020

Sheep Mentality 101: Fear Pays Poorly

The current market landscape is rife with an air of anxiety, as reflected by the soaring bearish sentiment, which has now hit a staggering 49. However, examining the underlying driving force behind this state of turmoil is crucial. The answer is simple: uncertainty. Despite this, it is intriguing to note that the number of individuals in the neutral camp has remained relatively stagnant for some time now. With last week’s reading at 27, and this week’s reading also standing at 27, this camp has remained firmly anchored within this range for weeks on end.

It is evident that the market is populated with individuals who are quick to jump from bullish to bearish camps and vice versa. This reactionary behaviour serves as fodder for the guillotine master’s dream, who relishes in the endless supply of heads in such an environment.

We have lemmings jumping back and forth from the bullish to the Bearish camps; this is the guillotine master’s dream come true, for the supply of heads is endless in such a setup.

If the current support at 27460 does not hold, then a break of 27K is expected at least on an intraday basis. Now the normal reaction for novice traders is to panic at the thought the markets could trend lower. In doing so, vital energy is wasted on viewing an opportunity through a negative lens. Individuals that take this approach are usually like deer frozen in front of a speeding truck. The glare of the headlights impairs their judgement, so even though they could quickly jump out of the way, fear keeps them frozen in place until the inevitable transpires. Market Update Sept 9, 2020

Embrace the Trend, for it’s your friend.

The crowd views disasters such as sharp pullbacks or so-called crashes through a negative lens because that is how they have been conditioned to react. Like a good computer, their minds follow the programming to a T; run in the face of panic and buy in the face of joy. Tactical Investor

The recent drop of the Dow to 27065 and the continued volatility in V-readings have generated a state of flux and uncertainty. As the Dow has followed the anticipated trajectory, we expect it to revisit the 27,000 range, given the extreme market conditions. However, it is essential to note that the trend remains positive, and as Tactical Investors, we must capitalize on these setbacks and fearlessly explore new opportunities.

Adopting this unconventional approach to adversity sets us apart from the masses who view sharp pullbacks or market crashes through a negative lens. They are held captive by the conditioning of their minds, programmed to react robotically – flee when panic strikes, and buy when joy abounds. We must break free from this rigid mindset and celebrate in the face of market chaos, as it is during these tumultuous times that great opportunities for gain reveal themselves.

A Condensed version of the Article

Sheep mentality has been a persistent issue for investors and traders, leading to the infamous boom-and-bust cycles that plague markets. Despite the evidence that the masses inevitably lose out due to this behaviour, many continue to follow the crowd, repeating the same mistakes of the past with precision.

One of the best examples of this is the case of Peter Lynch, who generated 29% annualised returns from 1977 to 1990, taking Fidelity’s Magellan assets past the $14 billion mark. Despite this, most individuals who invested in the fund lost money, falling victim to the secret desire to lose syndrome.

This syndrome occurs when investors try to outdo the fund manager, sell when the going gets tough, and purchase when everything looks rosy, a perfect recipe for destruction. Fidelity conducted an extensive study, revealing that the average investor not only fared poorly but didn’t even break even, highlighting the dangers of sheep mentality in investing.

The Pitfalls of Sheep Mentality in Trading and Investing

Today, bearish sentiment is at an all-time high, and the masses are almost in a frenzy, driven by uncertainty. The lemming-like behaviour of constantly jumping back and forth between bullish and bearish camps is the epitome of sheep mentality. It creates endless opportunities for the guillotine master to collect his bounty.

As Tactical Investors, it’s essential to recognise and overcome this sheep mentality by embracing pullbacks and daring to attempt the unimaginable. The separating factor between disaster and opportunity is perception, and celebrating in the face of carnage is critical to success in the market. Instead of blindly following the herd, Tactical Investors must look beyond the numbers and take a more rational and informed investment approach.

Research Supports Sheep Mentality  Hypothesis

A significant body of research supports the idea that herd behaviour can lead to poor investment decisions and adverse investor outcomes. For example, a study published in the Journal of Financial Markets found that herd behaviour among mutual fund managers can lead to lower investment returns for investors. The study found that fund managers were more likely to buy or sell stocks based on their peers’ behaviour rather than on the merits of the individual stocks. This herd behaviour led to a concentration of trades in certain stocks and sectors, which resulted in lower returns for the funds.

Another study published in the Journal of Behavioral Finance found that herd behaviour can lead to asset price bubbles and subsequent crashes. The study looked at the behaviour of investors during the dot-com bubble of the late 1990s and early 2000s and found that herd behaviour played a significant role in driving up asset prices to unsustainable levels. When the bubble burst, investors following the herd suffered significant losses.

Numerous other studies and real-world examples, such as the Magellan Fund case and investors’ behaviour during the financial crisis of 2008, support these findings. It is clear that herd behaviour can be detrimental to investment performance and that investors who can resist the temptation to follow the crowd and make independent, well-researched decisions are more likely to achieve positive outcomes.

Articles supporting the folly of following the pack

  1. “The Psychology of Herd Mentality in Trading and Investing” by Dr Kim Ann Curtin:
  2. “The Dangers of Groupthink: Lessons from the Bay of Pigs” by Irving Janis:
  3. “The Peter Lynch approach to investing” by Fidelity:
  4. “The Stock Market and the Folly of Crowds” by James Surowiecki:
  5. “The Madness of Crowds” by Charles Mackay:

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