Grazing bias in trading and investing is the situation in which people are Buying assets that others are buying. The strategy is generally known as following the crowd.
It is called grazing because of how animals such as cows gather in herds when grazing. In this article, we will look at what grazing bias is in trading and investing, and what its risks are How to use it for you.
What is grazing bias?
Cows and other animals tend to stay in groups most of the time. The herding bias in trade and investment, as mentioned above, refers to a situation where people buy the same things.
A good example of this is what happened during the meme stock investing mania that saw companies like GameStop and AMC soar. At that time, most novice investors rushed to buy these stocks.
Herding bias is too Popular with large and sophisticated investors. This happens when many large investors buy the same shares.
A good example of this is what happened in the last decade when most investors were buying companies like Apple, Amazon, Microsoft and Meta Platforms (formerly known as Facebook). In fact, some studies have shown that most investors buy the same assets.
Another type of bias in grazing is what happened during The crypto boom that happened in 2021. At the time, most of the day traders were buying digital currencies like Bitcoin and Ethereum.
Herding bias versus herding instinct
Herding bias is often determined by the herding instinct. The two are the same The herding instinct is a sociological term used to define the tendency of traders to identify themselves and to model their behavior on other people they identify with.
For example, most people in finance want to model their strategies after what successful investors like Ken Griffin and Warren Buffett do.
Examples of common herd bias in trading and investing
herd bias It is happening in the financial market All the time. Historically, there have been many examples of herd bias in the market. Most notably:
- The dotcom bubble – In the late 1990s and early 2000s, Internet companies flourished. When this happened, most of the investors bought these shares, including the shares of companies that do not have any revenues and profits. tThese investors lost a fortune when the stocks collapsed.
- EV mania — was the latest example of herd bias in EV mania. After seeing the success of Tesla, most of the investors started investing in EV companies like Rivian and Lucid. Then those stocks collapsed as concerns emerged about the industry.
- Spax – During the Covid pandemic, many finance professionals have launched their own SPACs that have taken companies like Virgin Galactic, Lucid, and DraftKings public.
- ESG Most companies and investors have adopted the ESG concept, which sees companies focus on environment, society and governance.
- encryption – During the pandemic, everyone moved to invest in cryptocurrencies, which led to a sharp rise in the prices of most currencies.
- passive investment Another big herding mentality is where investors focus on allocating cash to exchange-traded funds.
Follow the Crowd: Strategy or Bias?
A common question is whether bias grazing is a trading strategy or a bias. There are people who focus their trading strategy on following what other traders are doing. In most cases, this strategy It is often seen as momentum trading.
Momentum is a trading strategy that involves the buying and selling of financial assets When they are in a strong uptrend. Also known as trend following. The same situation can happen when traders sell assets whose prices are collapsing.
A good example of this occurred in early 2023 when investors dumped shares of Adani Enterprises after a scathing short-selling report. With the stock down, most of the existing investors dumped their shares and there were no buyers.
benefits
As we will show below, bias grazing carries significant risks that have cost investors billions of dollars. but, when it works well, He. She It can be an exciting trading strategy. Some of the benefits of this trading strategy are:
- that it basic strategy to follow – Using grazing bias, you only need to see an asset that others are buying and then buy it. You can also sell an asset that others are short selling. It has worked well in assets like Bitcoin and Tesla.
- Maybe very profitable The strategy can be very profitable when it is used well in the market.
- It works – While crowd tracking has risks, it works quite well. For example, people who bought Tesla shares when they were going up made a lot of money.
Cons of grazing bias
Grazing bias has a number of downsides, especially for people who don’t have experience in the industry. Some of these negatives are:
- Uninformed trading decisions It makes people make ill-considered trading decisions because they buy assets without making their own trading decisions.
- Big losses – As mentioned in the examples above, it can lead to huge losses in the market. For example, people lost billions of dollars during the Internet bubble.
- Not doing research Herd bias makes traders make decisions without doing any research.
- Rallies and false sales – Sometimes grazing bias can lead to false hikes and sell-offs in the wrong assets. For example, shares of Bed Bath & Beyond rose during the note stock mania despite the company’s weak fundamentals.
How to use herd bias well
There are several strategies to use when trading with the herd bias strategy. Some of these strategies are:
Use a trailing stop loss
This is a type of stop loss that moves with the financial asset. As such, when there is a major reversal, you will continue to keep the profits you made.
Trailing stop loss is better than fixed stop loss because it moves along with the volatility of the asset..
Do not leave your positions open overnight
When there is a crowd mentality follow, We often see a lot of volatility. You can mitigate this strategy by: Do not leave your trades open overnight.
Doing so will help you protect yourself when there is a big problem when the markets close.
Do your research
He should Always do your research When there is a mental problem herding bias. This research can include reading and finding out why the stock is going up or down.
Other risk management strategies do not use a lot of leverage and size your trades well.
summary
We have seen how following the crowd can have two different meanings in trading, although they are very similar to each other.
The first is strategy, whereby traders buy assets that are already going up or sell those assets that are going down to take advantage of their momentum. And as a strategy, it has its own analysis behind it.
Then there is the herding bias. As we’ve seen this still follows crowd decisions, but in way less aware and in control. Because of that, there are greater risks.
Useful external sources
- The herd effect in financial markets – Quantifier