As we continue our series on “Behavioral Biases”, we sought the expertise once again of the academic staff at www.Investopedia.com to discuss “Chasing Trends Bias”. Before we highlight their comments on this topic, we felt it helpful to provide an overview of how the broad phenomenon of “Chasing Trends” can lead to poor decision-making.
According to https://www.angora.solutions/post/the-dangers-of-chasing-trends-why-it-s-better-to-find-your-own-niche: “If you’ve noticed a trend you are definitely not alone. Several others who believe they’ve got some inside information have also noticed this new trend. You’ve noticed a huge new trend; all the kids are wearing chicken hats and you want to capitalize. After all, why shouldn’t it be you that rakes in a fortune and cashes out to enjoy the rest of your life on a beach due to your chicken hat fortune? There are many reasons why trying to jump on a trend likely won’t work out very well for you. It’s true that someone is raking it in due to this new fad, but the fact that you’ve already noticed it out in the world means it’s probably too late. Let’s look at why. When you list your chicken hats you are competing with everyone else who has noticed the chicken hat. Sure, you might be the best at SEO and be able to get your chicken hat right at the top of the feed, but you still have all those competitors who are also getting sales. Maybe the second or third listing has a unique style that is drawing eyes away from your listing. Maybe a big brand name decided to get into the chicken hat game. It really doesn’t matter where all this competition comes from. What matters is that it’s there, there is a lot of it, and it’s cutting into your business and leaving you with unsold merchandise.”
Hopefully, you get the broad picture leaving the good folks at Investopedia.com to translate this bias into investing terms. They go on to suggest; “This is arguably the strongest trading bias. Researchers in behavioral finance found that 39% of all new money committed to mutual funds went into the 10% of funds with the best performance the prior year. Although financial products often include the disclaimer that “past performance is not indicative of future results,” retail traders still believe they can predict the future by studying the past. Humans have an extraordinary talent for detecting patterns and when they find them, they believe in their validity. When they find a pattern, they act on it but often that pattern is already priced in. Even if a pattern is found, the market is far more random than most traders care to admit. The University of California study found that investors who weighted their decisions on past performance were often the poorest performing when compared to others. How to Avoid This Bias; If you identify a trend, it’s likely that the market identified and exploited it long before you. You run the risk of buying at the highs – a trade put on just in time to watch the stock retreat in value. If you want to exploit an inefficiency, take the Warren Buffett approach; buy when others are fearful and sell when they’re confident. Following the herd rarely produces large-scale gains.”
Sage advice indeed!!!
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