Sunday, December 14, 2008

Idea #12 - Social herding and game in investment strategy

At a time when information spread in lightening speed, and the financial market is enormously fluid, social behavior of the human society must be seriously considered, in addition to fundamental analysis and technical analysis, when making investment strategies.

Why do we herd ?
  • We (not just individuals but fund managers) follow investment advise of the same big shots.
  • We observe other people's decision and emulate.
  • We read the same news and reach similar conclusions (mostly).
  • and more.
How to exploit this? It would be far too easy if game theory can solve it already. It assumes that individuals are rational. However, we humans are not rational, far from it, from an economic point of view. (If you disagree, you should read Dan Ariely).

It has to do with psychology, sociology and randomness. I am yet to see a mathematical theory that will solve this problem. It would be Nobel worthy. Meantime, when you make the next investment decision, think twice, about how other might behave... ...

Note, some practical advice were offered by Nassim Nicholas Taleb.

Update, economists study this phenomenon under the name Information Cascade.

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