Quick definition Herding is when traders copy each other's behaviour, all moving in the same direction. If everyone is buying, others buy too. This amplifies price moves. What it is Herding can be rational (observing other informed traders and copying their strategy) or irrational (panic or overconfidence). Rational herding: if you see professional investors buying, you assume they have good reasons and you buy too. Irrational herding: everyone is buying and prices are rising, so you buy fearing missing out. Why it matters Herding creates instability. When many traders herd in the same direction, prices can move dramatically. Reversals are sudden when herding reverses. Herding also amplifies bubbles and crashes. In bubbles, everyone herds into buying. In crashes, everyone herds into selling. Feedback loops Herding creates positive feedback loops. Buying pushes prices higher, which encourages more buying, which pushes prices higher further. These loops are unstable. When the herd reverses, prices can crash just as fast. Information cascades An information cascade occurs when each person ignores their own information and copies others. If traders A and B buy, trader C assumes they have good information and buys without analysing. Cascades can propagate incorrect information and move prices away from fundamentals. Practical example A stock rallies 30 percent in a week on good news. Traders see the rally and start buying ("something's going on, I should buy"). The stock rallies another 20 percent on this buying. Traders are herding: they copy the direction without independent analysis. The rally is amplified by herding. When the herd turns (perhaps new information arrives), the stock crashes just as fast. Prevention Herding is hard to prevent. Circuit breakers and trading halts help by breaking feedback loops. Market structure that encourages diverse opinions (multiple venues, dispersed market making) reduces herding. See also - Panic Selling - Bubble - Momentum Trading - Information Cascade
