Herd behaviour

Also called: Herding · Topic: Schools of Economic Thought and Economic Laws · NCERT: Beyond NCERT

Meaning

Herd behaviour (also called herding) means people copy what a large group is doing and set aside their own information or judgement.

It matters because it is a systematic bias, not a random mistake. When many people make the same error in the same direction, the errors do not cancel out. They add up and move whole markets. This is how herding feeds asset bubbles, bank runs and IPO frenzies.

Explanation

How it works: the herding chain

• Homo economicus ("economic man") is the textbook person who uses only facts and their own careful calculation. Herding breaks this model: the crowd's action counts for more than the person's own information.
• The chain in a market:
• others are buying → I buy too
• prices rise further → more people see the rise and join
• a bubble forms (prices climb far above the asset's true worth)

• when the buying stops, the bubble bursts and prices crash

• The same chain runs in reverse in a panic: others sell → I sell → prices fall → more people sell.

Where it shows up

• Asset bubbles: share, gold or property prices driven up by "everyone is buying", not by earnings or real value.
• Bank runs: depositors rush to withdraw money because others are withdrawing. Even a healthy bank can fail if enough people panic together.
• IPO frenzies: an IPO (initial public offering) is a company's first sale of shares to the public. When an issue gets huge oversubscription (far more bids than shares on offer), others apply only because of the rush, not after studying the company.

Why people herd

• Bounded rationality (Herbert Simon, Nobel 1978): people have limited information, time and brainpower. Copying the crowd is an easy shortcut.
• Social norms: what people around us do, or expect us to do, pulls our choices.
• Fear of missing out: watching others gain feels like losing. This links to loss aversion from prospect theory (Kahneman–Tversky, 1979), where losses feel about 2 times as large as equal gains.
• Other biases often work together with it:
• Overconfidence: "I can catch the rally before it ends".
• Confirmation bias: reading only the good news that supports the crowd's view.
• Availability heuristic: heavy media coverage of people getting rich makes such gains feel likely.

What makes it stronger or weaker

• Stronger: rising prices, heavy media and social-media buzz, many new and inexperienced investors, low financial literacy, and fear during a crisis.
• Weaker: clear disclosure of risks, investor education, and rules that slow down panic, such as deposit protection that stops a run from starting.

In India

• Retail derivatives trading (SEBI studies): derivatives are contracts, such as futures and options (F&O), whose value comes from an underlying share or index. According to the study note, repeated losses here come from overconfidence, often together with herd behaviour and the sunk cost fallacy (continuing because of past spending that cannot be recovered).
• About 9 out of 10 individual traders in equity F&O made net losses in both FY 2018-19 and FY 2021-22 [3].
• 93% of individual traders made losses in equity F&O between FY22 and FY24. Their total losses were more than ₹1.8 lakh crore over those three years [1][2].
• 7 out of 10 individual intraday traders in the equity cash segment made losses (SEBI study, July 2024) [4].

• Most traders keep trading despite repeated losses, which shows the crowd pull is stronger than their own results.

• IPO rush: very high oversubscription of new share issues shows herding among retail investors.

• Using the herd for good (nudge): the Economic Survey 2018-19 said nudges work through social norms, meaning the wish to do what others do.
• Under Beti Bachao Beti Padhao (BBBP), #SelfieWithDaughter became a worldwide hit. Celebrating the girl child became a social norm that more people wanted to follow [5].
• The Swachh Bharat Mission (SBM) was also named as a success story [5].

Don't confuse with

• Overconfidence bias: overrating your own knowledge or forecasting skill. Herding is the opposite: you give up your own information and trust the crowd.
• Confirmation bias: looking only for information that confirms what you already believe. Herding is about copying other people's actions.
• Status quo bias: sticking with the current state or the default because of inertia. Herding means moving with the crowd, even into something new.
• Efficient-market hypothesis (EMH): says prices already reflect all available information, so no one can beat the market regularly. Herding is one of the biases behavioural finance uses to challenge EMH. It does not support EMH.

Prelims Hooks

• Herd behaviour means following the crowd and ignoring one's own information. It is listed in the study note among behavioural biases, along with Thaler's anomalies.
• It fuels three outcomes: asset bubbles, bank runs and IPO frenzies.
• Behavioural finance (Shiller, Thaler) argues that overconfidence and herding push prices away from their true value. Trap: behavioural finance challenges EMH.
• Thaler won the Nobel in 2017, a prize described as one for behavioural public policy [6]. Kahneman won in 2002, and Simon (bounded rationality) in 1978.
• SEBI: 93% of individual equity F&O traders made losses between FY22 and FY24, with total losses above ₹1.8 lakh crore [1].
• The Economic Survey 2018-19 chapter on "Nudge" cites #SelfieWithDaughter (under BBBP) as a social norm that more people wanted to follow [5].

Mains Points

• Retail investor protection (GS-III): herding, overconfidence and loss aversion help explain why 93% of individual F&O traders lost money between FY22 and FY24 (above ₹1.8 lakh crore in total) [1].
• This supports SEBI-type action on disclosure and entry barriers, alongside financial literacy.

• Trade-off: tighter entry rules protect small investors but limit their freedom to choose.

• Financial stability (GS-III): herding turns local fear into wider damage.

• A few withdrawals → panic → a bank run → a healthy bank can fail.
• Buying frenzies → bubbles → crashes that hit household savings.

• Regulators need to watch crowd behaviour, not only each bank's balance sheet.

• Herd instinct as a policy tool (GS-II/GS-III): nudges use social norms to spread good behaviour at low cost, as seen in SBM and BBBP (#SelfieWithDaughter) [5].

• Limits: nudges cannot replace mandates where the harm is serious [7]. Critics also call them paternalism, meaning the state deciding what is good for people.

Related concepts

• Behavioural economics
• Bounded rationality
• Satisficing
• Heuristics
• Anchoring
• Availability heuristic
• Confirmation bias
• Overconfidence bias
• Prospect theory
• Loss aversion

Read more

• Behavioural economics: bounded rationality, heuristics and biases