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Have you ever been to a sporting event or a rock concert and found yourself swept up in the emotion of the crowd? Have you ever found yourself doing the wave—standing up on cue along with the other mass of spectators? In fact, spectacles like football games and other events that include mass participation can have a powerful influence on our judgment and decision making. Sometimes rationality is left behind. The financial markets are no exception.

The idea that crowds and mob behavior rule the financial markets is not new. Gustav Le Bon (1841-1931) outlined how popular opinion can sway economic decisions in the classic book The Crowd. Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds and Humphrey Neill’s The Art of Contrary Thinking also shed light on how mob behavior and crowd psychology can impact the collective, sending financial markets into ridiculous bubbles followed by periods of extreme investor pessimism and despair.  

Today, the impact of the crowd is greater than ever. Unlike the early-20^th century, when investors met on the exchanges, we don’t see each other face to face. Instead, investors are linked through sophisticated electronic trading platforms. At any given time, I could be the other side of your trade—e.g. I’m buying what you’re selling. In addition, we have other things in common. For instance, we might read the same news reports or chat in the same investment communities.

Let’s face it, we live together in a new media world and the vast amounts of information flowing through this data ocean motivate our investment decisions. If the media tells us that worries about the housing sector are driving the market action today and another major bank is forced to record a major write-down, we might feel some uneasiness about the outlook for the credit markets and the economy. If crude oil bubbles above $100 a barrel, our thoughts might turn to worries about inflation and rising energy costs. When a market “guru” appears on CNBC and says that investors (you and me) have overreacted to the latest news, we might feel a bit of relief. “Oh, maybe everything is okay.”

The point is, the news that guides many of the decisions on Wall Street are actually stories that are created by “analysts,” fund managers, traders, and market strategists who each has their own reasons for their public relations efforts. They are, in fact, providing the news to the media. The media, in turn, is taking in what it considers most interesting and basically repeating what they hear. Their job is to report the news. Not make it.  In any event, these news bits are designed to interest investors and help them make sense of the happenings in the world of finance. They are, in most cases, rather dry and mundane.

However, at times, influential news will surface. These more interesting messages take the form of viruses and spread quickly throughout the media. Prior to the late-1990s, news that affected intraday market swings was available only on CNBC. Today, however, not only do several cable television stations offer market coverage, but the Internet has proved to be the most important channel for information to flow more freely among investors. Moreover, much of the actual news now surfaces on the Web first and then finds its way to other media sources like television, radio and newspapers.       

In this new media world, the power of mob behavior and crowd psychology in the financial markets is more influential than ever. However, rather than information flowing down from Wall Street houses, government stats, or television, the market moving news often flows from other sources, including Weblogs, independent information sources such as tradethemarkets.com or Briefing, and even message board chatter. In terms of information flow, the landscape has become much more horizontal and less vertical.

The question is, what information is truly worthwhile and/or how does one filter out what is relevant and what is useless? Unfortunately, there is no way to anticipate market-moving news before it happens. However, if the news is truly vital, the media will latch on to it. As the story makes the rounds, investors will react en masse, causing a significant reaction in the stock or the market. The more pervasive the story, the greater the chance that crowd psychology and mob behavior is driving prices out of fear or greed. And, like that time you stood up to do the wave at the football game, you might be caught up in it too.


Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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