5 Ways to Exploit Herd Mentality

Buy low and sell high.

In other words, buy when a stock is in the dumps, and sell it at a peak.

It’s the best investment advice ever given.  The problem is most people do the exact opposite. They sell low. Then, they buy high. They just sucked into the psychology and begin to trade on raw emotion instead of basing decisions on rational thought.

It happens all the time because of trading irrationality.  Many lose money because of it.

Yet, it’s the contrarian that tries to exploit the herd reaction that makes the most money. They follow the mantra, “If every one’s doing it, it’s wrong.”

When stocks are rising:

The herd reaction: “The stock is running fast. I have to get into it now. Every one else is. Oh jeez, I’m going to miss out.”

The contrarian reaction: “Wow. That looks overbought there. It looks like traders are rushing in for some reason. Let me look into why that’s happening.”

When stocks are falling:

The herd reaction:  “I don’t want to lose money and it looks like there’s no end in sight to this dip. I’m selling here for a loss.”

The contrarian reaction: “Look at all the blood in the streets. Let’s look into what caused this chaos and buy on oversold conditions.”

It happens every day. And the only folks that make money from it are the contrarians.

In September 2018, Tesla (TSLA) sold off harshly after the SEC sued Elon Musk for misleading others, and a bizarre video of him allegedly smoking a weed-laced cigarette on air. The herd ran scared.

Yet, it was the contrarian that stood to do the best, as even the shown technical pivot points became aggressively oversold. Shortly after, TSLA would run back from $270 to $311, before gapping back down to $270 again.

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The herd won’t win because they follow each other. That’s the worst thing to do. So how do you set yourself apart from the herd?

No. 1 – Buy when every one says sell. Sell when every one says buy.

It’s as simple as that. The best way to spot when the herd is wrong is by looking at the technical pivot points we highlighted above. They’ll tell you when traders are far too optimistic or far too pessimistic.

No. 2 – Never take tips or advice

Opinions are like your back end. Every one has one. Follow your instincts after doing your own research and due diligence. Don’t agree with every one and buy or sell what they suggest. Don’t regurgitate their ideas. If you see the bigger picture on your own, even if others suggest the opposite, trust yourself. 

There are no shortcuts to smart trading. Do your homework and don’t act on a trade because your know it all neighbor tells you to buy something. 

No. 3 – What is obvious to you isn’t obvious to others

There are a lot of “slow” traders out there. We all know this to be true. 

As a contrarian, you’ll never convince the greater herd to see things your way. But as long as you see something, trade it and wait for it to play out. Eventually, the rest of the herd will see the bigger picture, too after a long, long while. 

No. 4 – Don’t Mind the Noise

From the talking heads on CNBC to the headlines in The Wall Street Journal… they’ll sway sentiment. It’s your job as a contrarian to hear it, but not act on it until the rest of the herd has fully reacted. Once they react – most times the wrong way – pounce and ride the trade the opposite way. As Dr. Marc Faber once noted, “Follow the course opposite to custom and you will almost always be right.”

No. 5 – Have a Plan.  Stick with it.

As Sun Tzu once noted, “Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.”

As long as you are prepared for the hard battle, you’ll do just fine. Dig into numbers. Look at charts. Fight the good fight or be prepared to have your blood run in the streets, as Baron Rothschild referred to often. Contrarian investors must carefully plan ahead and rely on those plans. Fail to plan, and plan to fail. That’s the bottom line.