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THE PRACTITIONER’S PERSPECTIVE
Unconscious Herding Behavior as the Psychological Basis
of Financial Market Trends and Patterns
Robert R. Prechter, Jr.
Human herding behavior results from impulsive mental activity in individuals re-
sponding to signals from the behavior of others. Impulsive thought originates in the
basal ganglia and limbic system. In emotionally charged situations, the limbic sys-
tem’s impulses are typically faster than rational reflection performed by the neocor-
tex. Experiments with a small number of naïve individuals as well as statistics reflect-
ing the behavior of large groups of financial professionals provide evidence of
herding behavior. Herding behavior, while appropriate in some primitive life-threat-
ening situations, is inappropriate and counterproductive to success in financial situa-
tions. Unconscious impulses that evolved in order to attain positive values and avoid
negative values spur herding behavior, making rational independence extremely diffi-
culttoexerciseingroup settings. A negative feedback loop developsbecausestressin-
creases impulsive mental activity, and impulsive mental activity in financial situa-
tions, by inducing failure, increases stress. The interaction of many minds in a
collective setting produces super-organic behavior that is patterned according to the
survival-related functions of the primitive portions of the brain. As long as the human
mind comprises the triune construction and its functions, patterns of herding behav-
ior will remain immutable.
Experimental research suggests that human beings
possess biologically based psychological sources of
unconscious emotional imperatives that cause a coop-
erative interaction on the part of financial market par-
ticipants. If so, not only might mass emotional change
betheprimarymoveroffinancialmarketprices,butwe
may also expect its operation to be immutable.
The Triune Brain
Paul MacLean, former head of the Laboratory for
Brain Evolution at the National Institute of Mental
Health, has developed the concept of a “triune” brain,
i.e., one that is divided into three basic parts: the brain
stem, the limbic system and the neocortex.1While the
neocortex processes ideas by reason, the more primi-
tive portions of the brain control impulses and emo-
tions that propel actions that are lifesaving or life-en-
hancing under most circumstances. Along with such
matters as fighting, fleeing, hoarding, territorialism
and breeding, the basal ganglia control herding behav-
ior, while the limbic system produces emotions as a
spur to further these objectives. The rational cortex
cannot influence the impulses generated by these por-
tions of the brain.
As a primitive tool of survival, emotional impulses
from the limbic system impel a desire among individ-
uals to seek signals from others in matters of knowl-
edge and behavior and therefore to align their feel-
ings and convictions with those of the group. The
desire to belong to and be accepted by the group is
particularly powerful in intensely emotional social
settings, when it can overwhelm the higher brain
functions.
Anatomically related studies (Ledoux, 1989) led to
the discovery of neural pathways for emotional re-
sponse that do not go through the neocortex and which
are up to 40 milliseconds faster than the neocortex. Be-
cause the limbic system is quicker in response than the
neocortex, emotions are often not reactions to consid-
ered ideas but immediate reactions to perceptions re-
layed by the senses. Herding behavior, because it de-
The Journal of Psychology and Financial Markets
2001, Vol. 2, No. 3, 120–125 Copyright © 2001 by
The Institute of Psychology and Markets
120
Robert R. Prechter, Jr. is president of a financial market-fore-
casting firm. His latest book is The Wave Principle of Human Social
Behavior and the New Science of Socionomics (New Classics Li-
brary, 1999), which expands upon the subject of this article.
Requests for reprints should be sent to: Robert R. Prechter, Jr.,
Elliott Wave International, P.O. Box 1618, Gainesville, GA 30503.
Email: rprechter@elliottwave.com
rives from the same primitive portion of the brain, is
similarly unreflective and impulsive.
When are individuals’ herding impulses most like-
ly to be activated, making people join together to pro-
duce collective agreement in thought and action? De-
pendence upon the behavior of others most easily
substitutes for rigorous reasoning when knowledge is
lacking or logic irrelevant. In a realm such as invest-
ing, where so few are knowledgeable, or in a realm
such as fads and fashion, where logic is inappropriate
and the whole point is to impress other people, the
tendency toward dependence is pervasive. Trends in
such activities are steered not by the rational deci-
sions of individual minds but by the peculiar collec-
tive sensibilities of the herd.
Herding Psychology
and Financial Markets
In the 1920s, Pigou connected cooperative social
dynamics to booms and depression. His idea is that in-
dividuals routinely correct their own errors of thought
when operating alone but abdicate their responsibility
to do so in matters that have strong social agreement,
regardless of the egregiousness of the ideational error.
In Pigou’s words,
Apart altogether from the financial ties by which dif-
ferent businessmen are bound together, there exists
among them a certain measure of psychological in-
terdependence. A change of tone in one part of the
business world diffuses itself, in a quite unreasoning
manner, over other and wholly disconnected parts.
(Vittachi & Faber, 1998)
“Wall Street” certainly shares aspects of a crowd,
and there is abundant evidence that herding behavior
exists among stock market participants. Myriad mea-
sures of market optimism and pessimism2show that
in the aggregate, such sentiments among both the
public and financial professionals wax and wane con-
currently with the trend and level of the market. This
tendency is not simply fairly common; it is ubiqui-
tous. Most people get virtually all of their ideas about
financial markets from other people, through newspa-
pers, television, tipsters and analysts, without check-
ing a thing. They think, “Who am I to check? These
other people are supposed to be experts.” Many peo-
ple are emotionally dependent upon the ticker tape,
which simply reports the aggregate short-term deci-
sion-making of others. This dependence is nearly uni-
versal, even among long-term investors. They are
driven to follow the herd because they do not have
firsthand knowledge adequate to form an independent
conviction, which makes them seek wisdom in num-
bers. The unconscious says: You have too little basis
upon which to exercise reason; your only alternative
is to assume that the herd knows where it’s going.
When a crowd is in command, participating individuals
appear rational on the outside, but inside, their im-
pulses and emotions are in control.
Smith, Suchanek and Williams [1988] conducted
sixty laboratory market simulations using as few as a
dozen volunteers, typically economics students but in
some experiments businessmen. The subjects received
the same perfect knowledge of coming dividend pros-
pects and then an actual declared dividend at the end of
the simulated trading day, which could vary more or less
randomly but which would average a certain amount.
Despite this ideal environment of perfect knowledge, the
subjects in these experiments repeatedly created a
boom-and-bust market profile. The extremity of that pro-
file was a function of the participants’lack of experience
in the speculative arena. Head research economist
Vernon L. Smith came to this conclusion: “Experienced
subjects frequently produce a market bubble, but the
likelihood is smaller than for inexperienced subjects.
When the same group returns for a third market, the bub-
ble disappears.” In the real world, “these bubbles and
crashes would be a lot less likely if the same traders were
in the market all the time” (Bishop, 1987), but novices
are always entering the market. While these experiments
were conducted as if participants could actually possess
true knowledge of coming events and so-called funda-
mental value, no such knowledge is available in the real
world. The fact that participants create a boom–bust pat-
tern anyway is overwhelming evidence of the power of
the herding impulse.
The lower graph in Figure 1 shows the real-world re-
sult of the public’s impulse to herd. As you can see, the
general investing population commits more money to the
market as it rises and less as it falls, behavior opposite
from that which would generate profits.
It is not only novices and individual investors who fall
in line. It is a lesser-known fact that the vast majority of
professionals herd just like the naïve majority. The mid-
dle graph in Figure 1 shows the percentage of cash held
at institutions as it relates to the level of the S&P 500
Composite Index. As you can see, the two data series
move roughly together, showing that institutional portfo-
lio managers herd in the market’s direction for the most
part right along with the public.
Apparent expressions of cold reason by professional
stock analysts follow herding patterns as well. Finance
professorRobertOlsen[1996]conductedastudyof4000
corporate earnings estimates by company analysts and
reached this conclusion:
Experts’ earnings predictions exhibit positive bias and
disappointing accuracy. These shortcomings are usually
attributed to some combination of incomplete knowl-
edge,incompetence, and/or misrepresentation. This arti-
cle suggests that the human desire for consensus leads to
herding behavior among earnings forecasters.
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UNCONSCIOUS HERDING BEHAVIOR
122
PRECHTER
FIGURE 1
Evidence of Herding Behavior in Stock Market Activity
In that paper, Olsen shows that the greater the diffi-
culty in forecasting earnings per share, which is a
source of stress, the more analysts’herding behavior
increases. Equally important, the more their herding
behavior increases, the greater the bias in their earn-
ings estimates. The greater an aggregate bias becomes,
the less accurate are the aggregate forecasts. This is a
self-reinforcing system with failure the motivator of
further failure. Available records show that profes-
sional corporate analysts’ opinions track the trend of
the market, also in precisely the opposite fashion from
that which would generate profits.
The reason that forecasters’ inaccuracy worsens
with herding is that the net valuation of the stock mar-
ketistheresult of herding. To forecast on the basis of
the current sentiments of the herd is to “forecast” the
present mood, not future events. Success is simply a
matter of whether the present mood maintains, which it
usually does not.
How can seemingly rational professionals be so ut-
terly seduced by the opinion of their peers to the effect
that they will not only hold, but also change opinions
collectively? MacLean [1990] explains, “the limbic
system has the capacity to generate out-of-context, af-
fective feelings of conviction that we attach to our be-
liefs regardless of whether they are true or false.” In
other words, the neocortex is functionally disassoci-
ated from the limbic system. This means not only that
feelings of conviction may attach to utterly contradic-
tory ideas in different people, but also that they can do
so in the same person at different times. In other words,
a person may hold opposite views with equally intense
emotion, depending upon the demands of survival per-
ceived by the primitive portions of the brain. This fact
relates directly to the behavior of financial market par-
ticipants, who can be flushed with confidence one day
and in a state of utter panic the next. As Robert Schiller
put it in a New York Times article in 1989, “You would
think enlightened people would not have firm opin-
ions” about markets, “but they do, and it changes all
the time.” (Passell) In each case, they are fully capable
of explaining their new conviction, all such utterances
being simply (yet sometimes superficially brilliant)
rationalizations obediently generated by the neocortex.
As market analyst Paul Macrae Montgomery [1991]
explains, “to the limbic system, the phrase ‘net present
value of future cash flows’is meaningless because its
only sense of time is now and only value is pleasure or
relief from stress.” To relieve that stress without cogni-
tive dissonance, the neocortex must generate “reasons”
for a person’s action, which justify the attendant
emotional imperative. Throughout the herding pro-
cess, whether the markets are real or simulated, and
whether the participants are novices or professionals,
the conviction of the rightness of stock valuation at
each price level is powerful, emotional and impervious
to argument.
Emotional Stress as the Limbic
System’s Herding Motivator
Falling into line with others for self-preservation in-
volvesnotonlythe pursuitof positivevaluesbutalso the
avoidance of negative values, in which case the emo-
tions reinforcing herding behavior are even stronger.
Reptiles and birds harass strangers. A flock of poultry
willpeckto deathanyindividualbirdthat haswoundsor
blemishes. Likewise, humans can be a threat to each
otherif there areperceiveddifferences between them.It
is an advantage to survival, then, to avoid rejection by
revealing your sameness. D.C. Gajdusek [1970] re-
searched a long-hidden Stone Age tribe that had never
seen Western people and soon noticed that they mim-
icked his behavior; whenever he scratched his head or
put his hand on his hip, the whole tribe did the same
thing. Says MacLean, “It has been suggested that such
imitationmay have some protectivevalueby signifying,
‘I am like you.’” He adds, “This form of behavior is
phylogenetically deeply ingrained.” Thus, another ad-
vantageofherdingbehavior istheavoidanceof seeming
difference in order to defuse an excuse to attack.
This tendency toward mimicry is hardly confined to
Stone Age tribes. Psychology professor Irving Janis
[1972], after studying the dynamics of group decision
making in the modern political setting, concluded, “In
general, the greater the number of those in the decision
maker’s social network who are aware of the decision,
the more powerful the incentive to avoid the social dis-
approval that might result from a reversal.” What’s
more, “The greater the commitment to a prior decision,
the greater the anticipated utilitarian losses, social dis-
approval and self-disapproval from failing to continue
the present course of action and hence a greater degree
of stress.”
Thatis why,in financial markets, when thebest time
to buy or sell is at hand, even the person who thinks he
should take action experiences a strong psychological
pressuretorefrainfrom doingso. He thinks, if onlyhalf
consciously, “When my neighbor or advisor or friend
thinks it’s a good idea, then I’ll do it, too. If I do it now,
and I’m wrong, they will all call me a dope, and I’ll be
theonlydope.I’llbesingledoutfor ridicule,whichisnot
only agonizing but dangerous.” Pressure from, and in-
fluence by, peers, then, is at least one reason why most
peoplecannotbringthemselvestochangefrom abullish
to bearish orientation or vice versa if to do so would go
against the ideas of their associates and contacts. It also
explainswhya marketorother socialtrend cancontinue
for a long, long time and why financial valuations can
becomesoextremeasto appearoutrageoustothose who
believe that people ought to base their decisions ratio-
nally upon some calculable fundamental value.
The discomfort of being alone in one’s convictions
is so great that it involves physical reactions. “Emo-
tional mentation,” says MacLean, “represents the only
123
UNCONSCIOUS HERDING BEHAVIOR
form of psychological experience that, by itself, may
induce pronounced autonomic activity” such as sweat-
ing, twitching, flushing, muscle tightening and hair
standing on end. A person’s reaction just thinking
about taking an action apart from the herd can produce
tenseness or even nausea. He knows from experience
that anyone who shares a prevailing majority opinion
on any subject, particularly one that is intensely at-
tended by the emotions of the limbic system (such as
politics, religion, wealth or sex), is treated with the re-
spect due his obvious intelligence and morality. One
who utters an opposing opinion is immediately pun-
ished by a chorus of deprecating smiles, cackling,
mooing, snorting, nipping or outright hostility. It may
sound funny, but if you are not used to verbal vicious-
ness or rejection by the group, they are painful experi-
ences, and most people cannot abide either.
Emotionally removed historians sometimes decry
the lack of prescience among a population prior to a
long-ago financial crisis or the lack of vocal critics in
countries that are taken over by fascists, communists,
inquisitors or witch-burners. Yet unless one is there, it
is nearly impossible to imagine the social pressure to
go along with the trend of the day. In many political
and religious social settings, for example, “I am not
like you” can mean death. The limbic system bluntly
assumes that all expressions of “I am not like you” are
infused with danger. Thus, herding and mimicking are
preservative behavior. They are powerful because they
are impelled, regardless of reasoning, by a primitive
system of mentation that, however uninformed, is try-
ing to save your life. In many cases, it does just that.
Unfortunatelyfor humansin moderntimes,there are
important exceptions to that benefit. Herding behavior
is counterproductive to success in the world of modern
financial speculation. If a financial market is soaring or
crashing, the limbic system senses an opportunity or a
threat and orders you to join the herd so that your
chancesforsuccess orsurvivalwillimprove.Thelimbic
system produces emotions that support those impulses,
including hope, euphoria, caution and panic. The ac-
tionsthusimpelled leadoneinevitablyto theoppositeof
survival and success, which is why the vast majority of
people lose when they speculate.3In a great number of
situations, hoping and herding can contribute to your
well-being. Not in financial markets. In many cases,
panickingandfleeingwhen othersdocuts yourrisk.Not
in financial markets. Moreover, because impulses and
emotions result from rigid, “hard wired” thought pro-
cesses,repeated failure in speculation and the attendant
agony usually do little to deter the behavior.
From Individuals to Aggregates
We may not characterize these primitive impulses
and emotions as rational, as they operate independ-
ently of reason. Yet neither may we label them ir-
rational,becausetheyhave a purpose, no matter howill
applied in modern life. When the unconscious mind
operates, it could hardly do so randomly, as that would
mean no thought at all. It must operate in patterns pe-
culiar to it. This is clearly the case among speculators,
whose impulses produce the same patterns of aggre-
gate behavior over and over. Can we link such patterns
in individuals to the formation of a super-organic col-
lective pattern? There is evidence to support this hy-
pothesis as well.
Sornette and Johansen [1997] specifically connect
the stock market to the primitive mentation of animals,
including their occasional collective mentation: “In-
stead of the usual interpretation of the efficient market
hypothesis in which traders extract and incorporate
consciously (by their action) all information contained
in market prices, we propose that the market as a whole
canexhibit an ‘emergent’behavior notsharedby any of
its constituent[s]. In other words, we have in mind the
process of the emergence of intelligent behavior at a
macroscopic scale that individuals at the microscopic
scale have no idea of.” Biologists have made similar
analogies with respect to ant colonies, bee swarms and
other animal populations.
To form such emergent behavior, individuals’ im-
pulses to herd must relate to signals from the social en-
vironment. Since all participants in a particular social
settingshare the same environment, the combinationof
like minds produces global patterns of interactive dy-
namics in a social setting. This is particularly true of fi-
nancial markets, where participants hear the same
news and watch the same price quotations, thus receiv-
ing substantially identical signals. Since the partici-
pants themselves generate many of the signals, the re-
sult is a feedback loop of information and impulsivity.
This process generates the trends and patterns of prices
in financial markets.
As we have seen, the essential engine of the pro-
cess is the mass interaction of numerous rigid, unrea-
soning basal ganglia and limbic systems. We may
thus conclude that aggregate human interpersonal dy-
namics, and therefore the subset of speculative finan-
cial market dynamics, will remain immutable unless
and until there evolves a change in the operation of
the triune brain that constitutes the human mind.
Notes
1. I would like to thank Paul Macrae Montgomery of Universal
Economics for alerting me to MacLean’s material.
2. Such measures include put and call volume ratios, cash hold-
ings by institutions, index futures premiums, the activity of
margined investors, and reports of market opinion from bro-
kers, traders, newsletter writers and investors.
3. There is a myth, held by nearly all people outside of back-of-
fice employees of brokerage firms and the IRS, that many peo-
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PRECHTER
ple do well in financial speculation. Actually, almost everyone
loses at the game eventually. The head of a futures brokerage
firm once confided to me that never in the firm’s history had
customers in the aggregate had a winning year. Even in the
stock market, when the public or even most professionals win,
it is a temporary, albeit sometimes prolonged, phenomenon.
The next big bear market usually wipes them out if they live
long enough, and if they do not, it wipes out their successors.
This is true regardless of today’s accepted wisdom that the
stock market always goes to new highs eventually. Aside from
thefact that this very convictionis false (Where was the Roman
stock market during the Dark Ages?), what counts is when peo-
ple act, and that is what ruins them.
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