Investor BehaviorExplainer
What is herd behavior, and how does it feed market bubbles?
Herd behavior means following the crowd into or out of an investment. See how it feeds bubbles and panics, with 1929 and 2021 examples and warning signs.
Quick answer
Herd behavior is buying or selling because many other people are doing it, rather than because of your own analysis or plan. When enough people pile in together, prices can rise far and fast in a bubble, then fall sharply in a panic when the crowd turns.
Key points
- The SEC describes a mania or bubble as a rapid price rise driven by collective enthusiasm, usually followed by a contraction, and a panic as wide-scale selling that causes a sharp decline.
- In the 1920s the Dow rose about six-fold to 381, then fell to 41.22 by 1932, 89% below its peak; it did not regain the 1929 high until November 1954.
- In January 2021, GameStop's intraday price rose about 2,700% amid heavy online discussion, then fell to as low as $40.59 by February 19.
- Borrowed money magnifies both directions: with 10% down, a 10% price drop wipes out the investor's own money.
- Pitches built on 'everyone is buying it' and fear of missing out are warning signs, not reasons to act.
What is herd behavior in investing?#
Herd behavior means making investment choices mainly because other people are making them. The 2010 report on investor behavior that the Library of Congress prepared for the SEC lists following the herd among common investor mistakes, and links herd behavior to momentum investing — buying what has already gone up[1].
The pull is easy to understand. The SEC's investor alert on hot stocks says it can be tempting to jump on the bandwagon and follow whatever the crowd seems to be doing[2]. If many people are buying, it feels like they must know something. FINRA calls the same feeling by its popular name and advises investors to resist getting caught up in the fear of missing out (FOMO) on an opportunity that seems new or cutting-edge[3].
Following others is not always wrong. Buying a broad index fund that millions of people also own is not herd behavior in the harmful sense. The problem starts when the crowd's excitement replaces your own reasons — when "it's going up and everyone is in" is the whole case for buying.
What is a bubble, and what is a panic?#
The SEC's bulletin on investor behavior gives a clear pair of definitions. A financial mania or bubble is the rapid rise in the price of an investment, reflecting a high degree of collective enthusiasm or exuberance regarding the investment's prospects; this rise is usually followed by a contraction[4]. The contraction, or panic, occurs when there is wide-scale selling that causes a sharp decline in price[4].
How a crowd can push a price up and down
The loop shows why bubbles are hard to spot from inside. During the rise, every step seems to confirm the story: prices go up, people who bought earlier have gains, and more buyers arrive. The story only looks weak once new buyers run out.
What happened in the 1920s boom and the 1929 crash?#
The Federal Reserve's history site describes the 1920s boom as occurring during an era of optimism, when ordinary men and women invested growing sums in stocks and bonds[5]. The Dow Jones Industrial Average increased six-fold from sixty-three in August 1921 to 381 in September 1929[5].
Much of that buying used borrowed money. Purchasers put down a fraction of the price, typically 10 percent, and borrowed the rest[5]. By mid-November 1929, the Dow had lost almost half of its value, and the slide continued until the summer of 1932, when the Dow closed at 41.22, 89 percent below its peak[5].
- August 1921
The Dow stands at 63.
- September 1929
The Dow peaks at 381 — about 6 times its 1921 level.
- Mid-November 1929
The Dow has lost almost half of its value.
- Summer 1932
The Dow closes at 41.22, 89% below its peak and below its 1921 level.
- November 1954
The Dow finally returns to its pre-crash high.
Worked example
Worked example: the 1929–1932 fall in numbers
Using the index levels from the Federal Reserve's history essay, a fall from 381 to 41.22 is a loss of 89.2%. Climbing back from 41.22 to 381 needs a gain of about 824%. The 1932 low was even 34.6% below the August 1921 starting point, so the whole boom was erased.
| Measure | Value |
|---|---|
| Rise from 63 (Aug 1921) to 381 (Sep 1929) | 6.05 times, +505% |
| Fall from 381 to 41.22 (1932) | -89.2% |
| Gain needed to get from 41.22 back to 381 | +824% |
| 1932 low compared with 1921 start | -34.6% |
| Time from 1929 peak to recovery (Nov 1954) | About 25 years |
Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.
These are index levels, not the returns of any particular investor, who may also have received dividends or used borrowed money. But they show how far a crowd-driven rise can unwind.
What did the 2021 GameStop surge show?#
A modern example comes from an SEC staff report on market events in early 2021. GameStop (ticker GME) closed at $347.51 on January 27, 2021, a more than 1,600% increase from its close on January 11, and hit an intraday high of $483.00 the next day[6]. The report says the intraday price rose approximately 2,700% from January 8 to January 28[6].
The report ties the moves to crowd attention: they coincided with substantial interest expressed in certain online forums devoted to investing, including YouTube channels and the subreddit WallStreetBets[6]. Then the crowd thinned. By February 3 the price was below $100, and it fell as low as $40.59 by February 19[6] — about 91.6% below the $483.00 high.
| Episode | The rise | The fall | Source |
|---|---|---|---|
| Dow Jones average, 1921–1932 | 63 to 381 (about 6 times) | 381 to 41.22 (-89.2%) | Federal Reserve History |
| GameStop shares, Jan–Feb 2021 | About +2,700% intraday, Jan 8 to Jan 28 | $483.00 to $40.59 (-91.6%) | SEC staff report |
Percentage falls computed in code from the levels each source reports. Past episodes do not predict the size or timing of future ones.
Why does following the crowd add risk?#
Late buyers in a crowd-driven rise pay the highest prices. The SEC alert explains the logic many of them follow: a momentum investor believes that large increases in price will be followed by additional gains[2]. That works only while new buyers keep arriving. The same alert warns that short-term trading can lead to significant and unanticipated losses for retail investors[2].
Borrowing makes it worse. With a margin loan, the investor puts up part of the price and borrows the rest. The SEC alert notes that with margin you can lose more money than you have invested[2]. The arithmetic below uses the 10% down payment the Federal Reserve history essay describes for the 1920s.
Worked example
Worked example: buying $100 of stock with $10 down
An investor puts in $10 of their own money and borrows $90 to buy $100 of stock. A 10% rise doubles their own money, but a 10% fall wipes it out, and a 20% fall leaves them owing $10 more than the stock is worth. Loan interest and fees would make each result worse.
| Price move | Value of the stock | Investor's own money | Change in own money |
|---|---|---|---|
| Price rises 10% | $110.00 | $20.00 | +100% |
| Price falls 5% | $95.00 | $5.00 | -50% |
| Price falls 10% | $90.00 | $0.00 | -100% |
| Price falls 20% | $80.00 | -$10.00 | -200% |
Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.
Margin rules and limits differ by country and by firm, but the principle is the same: borrowed money magnifies both gains and losses. Our note on volatility and drawdowns explains how to size up the downside, and diversification explains why a single crowded stock should not be a large share of a portfolio.
How can you spot herd pressure before you act?#
Fraudsters use herd psychology on purpose. Investor.gov tells investors to watch out for pitches that stress how "everyone is investing in this, so you should, too"[7]. In a pump-and-dump scheme, FINRA explains, promoters quietly buy shares, hype them through the internet, social media and messaging apps, then sell as the price rises — and the crash often happens very rapidly, sometimes in a matter of seconds[8]. See our guide to investment fraud red flags.
- Ask for the reason without the crowd. If you removed "it's going up" and "everyone is buying", would any reason to buy be left?
- Check where the excitement comes from. Message boards, chat groups and influencers are not research. The SEC suggests reviewing publicly disclosed company information before you invest[2].
- Notice urgency. A feeling that you must act today is a signal to slow down.
- Size it as if it could go to zero. If you still want to take part, keep the amount small enough that a total loss would not change your plans.
- Avoid borrowing to join a rally. Margin turns a painful fall into a loss larger than your money.
Crowds also drive selling. A panic can tempt you to sell at the bottom along with everyone else. Our notes on loss aversion and market timing cover that side of the story.
What mistakes do beginners make?#
Buying because a price has already gone up a lot
A big past rise is not a reason by itself. Late buyers in a crowd-driven rise pay the highest prices and face the sharpest falls.
Treating online buzz as research
Popularity on social media or forums says nothing about a company's finances. Read the company's own filings before deciding.
Using borrowed money to join a rally
Margin magnifies losses as much as gains, and can leave you owing more than you invested.
Selling in a panic because everyone else is
In a panic, wide-scale selling drives prices sharply lower, and anyone who sells with the crowd locks in the fall up to that point. Check your plan before following the exit rush.
What else do beginners ask?#
How can I tell a bubble from a normal rally?
It is hard to tell while it is happening. The SEC defines a bubble by a rapid rise driven by collective enthusiasm that is usually followed by a contraction[4]. A practical test is the reason given for buying: if it is mostly that others are buying, be careful.
Is buying a popular index fund herd behavior?
Not in the harmful sense. Owning a broad, diversified fund as part of a long-term plan is a deliberate choice, not a reaction to a crowd. Herd behavior is about chasing what others are buying because they are buying it.
How long did the market take to recover after 1929?
According to the Federal Reserve's history essay, the Dow did not return to its pre-crash heights until November 1954[5]. That is a long wait, and it is one reason not to treat any past recovery time as a guide to the next one.
What is FOMO in investing?
FOMO stands for fear of missing out: the urge to buy because others seem to be profiting. FINRA advises investors to resist it, especially for opportunities that seem new or cutting-edge[3].
What is the bottom line?#
Herd behavior is a natural instinct: when many people are buying, it feels safe to join. In markets that instinct can push prices far beyond what supports them, and the fall that follows is often sharp — 89% for the Dow from 1929 to 1932, and more than 90% from GameStop's 2021 high. You cannot stop crowds from forming, but you can decide in advance that "everyone is buying" will never be your reason, avoid borrowing to chase a rally, and keep any speculative bet small.
Sources
Numbers in brackets in the text point here. Grade A = primary source (regulator, statistics agency, law or official document).
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