`Herd instinct' rules stock market

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The Independent Online
THE STOCK MARKET is ruled as much by the "herd instinct" of traders, as any rational assessment of a company's worth, scientists have found.

The assessment, based onmathematical assumptions more familiar to physicists, has revealed that stock markets are a fundamentally irrational enterprise. Thomas Lux, professor of economics at the University of Bonn, and Michele Marchesi of the University of Cagliari in Italy, show in the journal Nature that some traders exert a significant influence on share prices by merely following the crowd.

The researchers found that traders adopted two clear strategies. One, the "fundamentalist", expected prices to follow a company's future worth. The other, the "noise trader", tried to identify what other traders would do in order to anticipate price changes.

"Instead of focusing on fundamentals, these agents attempt to identify price trends and patterns and also consider the behaviour of other traders as a source of information, which results in a tendency towards herding behaviour," the researchers say.

Within this group there are pessimists, who will sell shares irrationally, and optimists, who will buy them for the same illogical reasons.

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