...investors feel the pressure to conform. The CFA Institute surveyed more than 700 investors and found that “being influenced by peers to follow trends” was the behavioral bias that affected decision making the most.
- Shreenivas Kunte, “The Herding Mentality: Behavioral Finance and Investor Biases,” Enterprising
Investor, August 6, 2015
Trend-following is a disciplined approach for using price information to determine the current direction of a market and dynamically investing on those trend signals. The following of peers or herding is not a price-based discipline but an extrapolation of market views and expectations. It is not based on systematic price behavior and is not disciplined. The ad hoc nature of trend-following based on peers influence is an approach to investing but not a definable system of investment rules.
The idea of return chasers was more formally tested in a paper, Return Chasing and Trend Following: Superficial Similarities Mask Fundamental Differences by the folks from Elm Partners. Return chasers are stylized as proportionally changing their market exposure based on past returns. Their example is inferior to a trend system that enters or exits the market fully on a signal. What it does show is that scaling in and out of positions based on trend is ineffective.
Trend-followers may exploit herd behavior if it is manifested in price. Trend-followers respond to prices not on the opinions or musing of others but on the weighting of past prices. Trend-followers make money because they emphasize a consistent process. Trend-followers are not sensitive to peer pressure and given years of derision during the efficient market hypothesis period, they were somewhat view as outcasts.
Investors may be viewed as trend-follower because they chase performance, only picks recent winners, and sort on performance. However, trend-following professionals often exploit this undisciplined, casual, and unsystematic approach to trends through the investment scaling of chasers. Investor behavior driven by tracking the opinion of peers is a form of trend following and may create price trends; however, it is not the same as a disciplined approach to finding trade opportunities through rules-based behavior.
The idea of return chasers was more formally tested in a paper, Return Chasing and Trend Following: Superficial Similarities Mask Fundamental Differences by the folks from Elm Partners. Return chasers are stylized as proportionally changing their market exposure based on past returns. Their example is inferior to a trend system that enters or exits the market fully on a signal. What it does show is that scaling in and out of positions based on trend is ineffective.
Investors may be viewed as trend-follower because they chase performance, only picks recent winners, and sort on performance. However, trend-following professionals often exploit this undisciplined, casual, and unsystematic approach to trends through the investment scaling of chasers. Investor behavior driven by tracking the opinion of peers is a form of trend following and may create price trends; however, it is not the same as a disciplined approach to finding trade opportunities through rules-based behavior.
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