Stock Market Herding


A combination of low oil prices and turmoil in the China market was believed to have led to the drop you see below in January 2016 of the S&P 500. But were these reasons legit?

2016 drop spy

As the article points out, there may have been evidence of a mild slowdown in China’s economic growth, but nothing near as catastrophic as the drop in the market suggested. Similarly, a decrease in oil prices is generally anticipated to benefit oil consuming countries such as the US by increasing consumer spending and boosting the economy. Instead, headlines claimed that low oil prices lead to a decrease in stock prices. Did these factors really warrant a 10% drop in the market? It seems as though the answer is ‘no’ because just two months later, the market had returned to its original level. So what could be the reason for such a big drop? Herding. Investors are heavily influenced by each other and act upon sudden movements in the market. The general assumption is that if a stock price is moving sharply and I don’t know why, someone knows something that I don’t. Therefore, as an investor, I tend to follow the trend even though I might not know the underlying reason for the selloff. Information cascades happen all the time in the stock market and often lead to overcorrections such as the one in January of this year. Once investors begin to look into the underlying reasons after the fact, they realize the news wasn’t as big a deal as the price change suggested and stock prices recover as they did in March/April.

So what’s the lesson here? Don’t trust anyone.

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