What is conventional wisdom?

Challenging the Herd: What Is Conventional Wisdom?

Nov 27, 2024

Introduction:

Conventional wisdom is the silent dictator in a world drowning in noise, where trends are worshipped, and dissent is punished. It’s the unspoken agreement, the collective nod, the easy answer that requires no thought. But here’s the truth: conventional wisdom is often a lie. It’s a crutch for the lazy, a trap for the complacent, and a weapon for those who profit from the blind obedience of the masses. To rise above mediocrity, you must learn to see it for what it is—a comforting illusion that often leads to ruin.

The Mirage of Collective Truth

Conventional wisdom is not truth. It’s a shortcut, a way to avoid thinking critically. It thrives because it feels safe. It tells you to follow the crowd, to trust the majority, and to believe that if everyone else is doing it, it must be right. But history is littered with the corpses of those who trusted the herd. The crowd is not wise; it is blind. It moves not with reason but fear, greed, and the desperate need to belong.

The Illusion of Safety in Numbers

The stock market crash of 1929 is a brutal reminder of what happens when people blindly follow conventional wisdom. In the Roaring Twenties, everyone believed the same lie: that stock prices would rise forever. People mortgaged their homes, emptied their savings, and threw everything into the market. They trusted the crowd. They trusted the experts. They trusted the illusion.

And then it all collapsed. The bubble burst, and the Great Depression followed. Millions lost everything because they believed what everyone else thought. This is the danger of conventional wisdom—it feels safe until it isn’t. The herd will lead you to the cliff’s edge, and it will take you with it when it falls.

The Psychology of the Crowd

Why do we follow the herd? It’s easy, comfortable, and terrifying to stand alone. Human beings are wired to seek safety in numbers. It’s an evolutionary instinct that once kept us alive. But in the modern world, it’s a weakness. It makes us vulnerable to manipulation, groupthink, and the seductive pull of the majority.

In finance, this is called herd mentality. When the market rises, people rush to buy. When it falls, they panic and sell. They don’t think. They react. They follow the crowd, assuming the crowd knows something they don’t. But the crowd is often wrong. It’s driven by emotion, not logic. And those who follow it are the first to be crushed when the tide turns.

The Rebel Advantage: Thinking Beyond the Crowd

It would be best to learn to think for yourself to succeed in a world dominated by conventional wisdom. The greatest minds in history—Einstein, Jobs, Musk—did not follow the herd. They questioned everything. They challenged the status quo. They saw what others couldn’t because they refused to accept what everyone else believed.

Warren Buffett, one of the most successful investors of all time, has a simple rule: be fearful when others are greedy, and greedy when others are fearful. This is the essence of independent thought. It’s about seeing the world as it is, not as the crowd wants you to see it. It’s about making decisions based on reason, not emotion. It’s about having the courage to stand alone when everyone else is rushing in the wrong direction.

Mass Psychology: The Driver Behind Market Movements

Human emotions play a significant role in financial decisions. Fear and greed are powerful motivators that can overshadow logical analysis. During the dot-com bubble of the late 1990s, investors were gripped by the fear of missing out on the next big tech company. Conventional wisdom suggested that any company related to the internet was a goldmine. This led to astronomical valuations of companies with little to no earnings.

When the bubble burst in 2000, the Nasdaq Composite index plummeted nearly 80% over two years. Investors who had bought into the hype suffered massive losses. This market collapse highlighted how mass psychology, fueled by greed and the desire to follow prevailing trends, can lead to irrational investment decisions.

Technical analysis offers tools to navigate beyond conventional wisdom by examining statistical trends gathered from trading activity. Indicators such as moving averages, volume trends, and relative strength index (RSI) can reveal underlying market sentiments that are not immediately apparent. For instance, a divergence between a stock’s price and RSI can signal a potential reversal, alerting investors to reconsider their positions.

During the housing bubble of the mid-2000s, technical indicators showed warning signs that were largely ignored due to prevailing beliefs that real estate prices would perpetually rise. The S&P/Case-Shiller Home Price Indices began to show a plateauing of home prices even as mortgage lending continued at a breakneck pace. Investors who paid attention to these signals could have anticipated the impending crash, avoiding significant losses.

Contrarian Thinking: The Antidote to Conventional Wisdom

Contrarian investors thrive against prevailing market trends, challenging conventional wisdom to uncover undervalued opportunities. This approach requires a keen understanding of mass psychology and the discipline to act independently of popular opinion. Legendary investor Sir John Templeton famously said, “Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.” Recognizing these phases allows contrarians to buy when others are selling and sell when others are buying.

During the financial crisis 2008, while panic gripped the markets, some investors recognized the overselling of fundamentally strong companies. They strategically bought shares at depressed prices, leading to significant gains in the subsequent market recovery. This strategy hinged on resisting the fear that dominated the market and trusting in thorough analysis over collective panic.

Investors often experience a predictable emotional cycle influenced by market fluctuations. At the market’s peak, euphoria can lead to overconfidence and increased risk-taking. Denial and fear set in as the market declines, leading to rash decisions like panic selling. Understanding this cycle is crucial for making rational investment choices.

A study by DALBAR found that the average investor underperforms the market due to behavioural biases, primarily the tendency to buy high during optimistic periods and sell low during pessimistic ones. By recognizing these emotional responses, investors can develop strategies to mitigate impulsive decisions driven by conventional wisdom.

Timing Is Everything: Strategic Buying and Selling

Effective investment timing involves recognizing when market prices deviate significantly from intrinsic values. Technical analysis can help identify these moments. For example, the price-to-earnings (P/E) ratio can indicate whether a stock is over or undervalued compared to its historical average or industry peers. During the dot-com bubble, some companies had P/E ratios in the hundreds or even thousands, signalling extreme overvaluation.

Strategic buying during market crashes requires the courage to act against prevailing pessimism. In March 2009, the S&P 500 reached a 12-year low at the height of the financial crisis. Investors who recognized the market was oversold and bought at this point benefited from one of the longest bull markets in history, as the index more than quadrupled over the next decade.

Fear and euphoria are powerful emotions that can cloud judgment. Euphoria can lead to speculative bubbles, as seen with the cryptocurrency surge in 2017. Bitcoin’s price skyrocketed from under $1,000 to nearly $20,000 within a year, driven by hype and the belief that prices would continue to rise indefinitely. When reality set in, the price plummeted, leaving late entrants with significant losses.

Conversely, excessive fear can create buying opportunities. During the COVID-19 pandemic’s onset in March 2020, global markets experienced sharp declines due to uncertainty. Investors who managed their fear and invested in strong businesses during the downturn benefited from the rapid recovery, as markets rebounded to record highs within months.

Questioning Conventional Wisdom: A Path to Clarity

Challenging conventional wisdom requires critical thinking and a willingness to diverge from the majority. It’s essential to conduct independent research, assess fundamentals, and understand the psychological factors at play. This approach doesn’t guarantee success but increases the likelihood of making informed decisions aligned with one’s investment objectives.

Investors can also benefit from studying market history to recognize patterns influenced by collective behaviour. Understanding past events, such as the South Sea Bubble or the Tulip Mania, can identify similarities in current market conditions that may signal irrational exuberance or unwarranted pessimism.

Conclusion: Redefining Investment Success

Conventional wisdom offers comfort but can lead investors astray when driven by mass psychology rather than sound analysis. Recognizing the impact of herd mentality, emotional biases, and the importance of timing can empower investors to make more rational decisions. By questioning widely held beliefs and embracing contrarian strategies when appropriate, investors position themselves to navigate market cycles with greater confidence and clarity.

To challenge conventional wisdom is not to be reckless. It is to be bold, deliberate, and unrelenting in your pursuit of truth. It is to reject the easy path in favour of the hard road that leads to greatness. It is to see the world not as it is presented to you but as it truly is.

The crowd will always try to pull you back. It will mock you, doubt you, and punish you for daring to think differently. But remember this: the crowd is not your friend. It is a prison. And the only way to escape is to break free from the chains of conventional wisdom.

So the next time you’re faced with the comforting lie of the majority, ask yourself: is this the truth, or just the easy answer? And then, with all the courage you can muster, choose the harder path. The path of the rebel. The path of the thinker. The path of the one who dares to challenge the herd.