Explain how recency and herding lead people to buy high and sell low.
Before you buy any investment, write down in a sentence or two why you are buying it and what would make you sell. The reason has to be about the investment itself, such as its place in your plan or the business and its price, and not about what other people are doing or how much the price has risen lately.
Darren (an invented example) does not think of himself as an investor. Last year his office WhatsApp group spent three weeks talking about a US tech stock that had doubled in a few months. One colleague had bought early and kept posting screenshots of the gains. Another called it "the next big thing".
By the time Darren opened a broker account and put in S$2,000, the stock had been rising for most of a year. Over the next five months it fell 45%. He sold at S$1,100, convinced it would fall further. It then recovered part of the way without him.
Three habits of mind were acting on Darren at once, and they act on most people in much the same way.
People tend to expect recent trends to continue. Something that has risen feels like it will keep rising, and something that has fallen feels like it will keep falling. Psychologists call this recency bias, which means giving recent events too much weight. In investing it pushes people to buy after rises and sell after falls.
This pattern is behind the behaviour gap covered in lesson 1.3. Investors put money into funds after strong years and take it out after bad ones, so most of their money is in a fund just before its worst stretch. Nobody means to buy high and sell low. Recency bias makes buying high feel like following the evidence, and selling low feel like getting out before it is too late.
Past returns are a weak guide to future returns, especially over months rather than decades. A strong year often means prices already reflect a lot of good news, which can make the next few years harder. A strong year does not mean a fall is coming, though. It only means one rise does not promise another.
Herding means buying or selling because other people are, rather than for your own reasons. It is not irrational in every setting: if everyone is leaving a building, following them is usually wise. In markets it works less well, because by the time a crowd forms, the price has usually already moved.
Herding used to spread through newspapers, brokers and conversations at work. Now it spreads through chat groups, forums, social media and short videos. A stock or coin can become the subject of thousands of posts in a few days, and each post makes the idea feel more widely backed and more urgent. The screenshots of gains are real, but they come from people who bought early, posted at the high point and have not yet posted the fall.
Fake investment platforms and "insider" groups exploit herding heavily. They are covered in Scam-proof your money, lesson 4.3, "Fake celebrity ads, insider groups and trading mentors". The focus for now is the legal version: real shares and real funds bought for the wrong reasons.
Fear of missing out (FOMO) is the feeling that everyone else is getting rich and you are being left behind. It grows as a boom continues. Early in a rise, few people notice. As prices climb, more people talk about it and more people you know have made money, so the pull gets stronger. FOMO therefore usually peaks when prices are already high, which is the worst time for it to drive a decision.
Nobody, including you, can know where the top is. You can notice when your main reason to buy is that other people have made money from it. "Everyone is buying" and "it's up 80% this year" (an example figure) are not reasons about the investment at all.
If Darren had written down his honest reasons before buying, they would have been "everyone in the group is in" and "it's gone up so much". Neither says anything about whether the company was worth S$2,000 of his savings at that price.
A written reason forces you to state something about the investment rather than about other people. One good reason is that the investment is in your plan as part of your world equity allocation. Another is that the company earns more each year and the price is reasonable relative to those earnings, which you can check later. If you cannot write a reason that would survive a friend's questions, treat that as a warning.
The sell condition matters as much as the buy reason. Tie it to the business or your plan rather than to the price. A falling price on its own then does not set off a panic sale; it sends you back to ask whether the business has changed.
Suppose Darren had written "I'll sell if the business itself gets worse" before he bought. When the price fell, he would have checked whether the business had changed and found that mostly it had not, and the fall alone would not have pushed him into selling at S$1,100.
Before your next purchase, write one or two sentences on why you are buying. Check that the reason is about the investment and would survive a friend's questions. Write down what would make you sell. If the price falls later, reread that condition and check whether the business has actually changed before you act.
Think about one investment you bought, or nearly bought, mainly because others were buying it, and what happened afterwards.
Write down one investment you bought or thought about buying because other people were buying it, and what happened afterwards.
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