Summary (quick answer): Herd mentality is when investors chase what “everyone else” is buying or selling—often driven by FOMO—ignoring fundamentals. In India, you’ve seen it during the 1992 bull run, the 2017–18 small-cap frenzy, the 2021 IPO boom, the IL&FS-led NBFC scare in 2018, and the Adani episode in 2023. Understanding these patterns helps you avoid overpaying and manage risk. (IMF)
Last updated: August 15, 2025
What exactly is herd mentality?
Herd mentality (or herding) is the tendency to mimic the crowd’s trades instead of relying on your own analysis. Classic behavioural finance distinguishes “intentional” herding (copying others) from “spurious” herding (similar decisions because information is similar). The first is dangerous; the second can be rational. (IMF)
Why it matters: Herds inflate bubbles and deepen crashes, leading to poor entry prices, excessive concentration, and liquidity risk when the stampede reverses.
Useful formulas
- Drawdown (%) = Peak−TroughPeak×100\frac{\text{Peak} – \text{Trough}}{\text{Peak}} \times 100
- Turnover Velocity = Monthly Traded ValueFree-Float Market Cap\frac{\text{Monthly Traded Value}}{\text{Free-Float Market Cap}}
- PEG = P/EEPS growth (%)\frac{\text{P/E}}{\text{EPS growth (\%)} } — extreme PEGs often signal crowding.
Five Indian case studies of herd behaviour
1) The 1992 bull run and subsequent “securities scam”
A powerful rally, broker leverage and opacity in the banking–markets plumbing culminated in the 1992 bust. The Joint Parliamentary Committee’s report details the mechanics and reforms that followed (screen-based trading, settlement changes, tighter supervision). Lesson: when structure enables easy leverage and stories spread faster than scrutiny, crowds can overwhelm controls—until they can’t. (Digital Sansad, watchoutinvestors.com, SAGE Journals)
2) 2017–18 small-cap euphoria—and the sharp comedown
Mid- and small-cap indices surged into January 2018 as narratives of “domestic growth + reforms” crowded trades; then valuations mean-reverted and small caps corrected materially through 2018–19. Academic and market evidence shows a clear boom into early 2018 followed by a sustained decline until March 2020. Lesson: rich multiples with narrow breadth are fragile. (ScienceDirect, The Economic Times)
3) 2018 IL&FS default and the NBFC/liquid-debt fund scare
When IL&FS defaulted (AAA-rated until just before), funding conditions for NBFCs tightened abruptly. Investors herded out of lower-quality credit, widening spreads and forcing mark-downs in debt funds. Lesson: credit herding flips quickly—crowded yield hunts can become crowded exits. (Harvard Kennedy School, Quartz)
4) 2021 IPO boom—oversubscriptions, hype, and reality checks
India saw a frenzy of tech and brand IPOs in 2021. Paytm’s record-size issue was subscribed but disappointed on listing and later fell well below issue price, while peers like Zomato eventually diverged based on delivery of profitability. Lesson: “hot” IPOs reflect herd sentiment; post-listing returns follow fundamentals. (Reuters, Fortune)
5) 2023 Adani episode—fast crowding, faster de-crowding
The Hindenburg report triggered a sharp, high-volume sell-off across the group in early 2023; later, parts of the complex recovered on fund-raising and changed ownership narratives. Herding amplified both down and up legs. Lesson: in concentrated narratives, flows beget flows. (Reuters)
What signals often precede herd peaks?
Use this practical checklist. Multiple red flags together are more telling than any single indicator.
- Price >> Earnings
- 12M price return largely from P/E re-rating (not EPS growth).
- Rule of thumb: If >60–70% of gains are multiple expansion, crowding risk is high.
- Turnover spikes
- Turnover Velocity well above its 1–2 year median suggests speculative churn.
- Narrow breadth
- Fewer stocks driving the index advance; advancers/decliners ratio weak on up days.
- Hot IPO calendar
- Heavy oversubscriptions + weak after-market support point to excess demand without long-only sponsorship. (Reuters)
- Leverage & pledging
- Rising promoter pledging or margin funding can fuel both rallies and sell-offs.
- Narrative virality > diligence
- Social-media-driven “must-own” themes with simplified KPIs crowd retail flows (SEBI’s recent investor alerts reflect these risks). (The Times of India)
- Policy and liquidity turns
- Tightening liquidity (RBI stance, global rates) can pop crowded trades—watch the macro backdrop.
Illustration: When returns are mostly re-rating
The chart shows a hypothetical 12-month 100% price return split into 20% earnings growth and 80% P/E re-rating. When most of the gain is multiple expansion, a modest disappointment can cause a sharp reversal—classic herd risk.
A disciplined playbook to avoid getting trampled
1) Pre-commit to valuation bands
- For equities: insist on a margin of safety (e.g., sector-adjusted P/E, EV/EBITDA, or PEG < 1–1.5 for growth stories).
- For funds: prefer diversified market-cap exposure over narrowly crowded small-cap themes at stretched valuations.
2) Stagger entries and exits
- Use SIPs or tranche buys; take profits gradually as P/E contribution to returns rises.
3) Position sizing
- Cap any single stock at, say, 5–7% and any single theme at 15–20% of the portfolio.
4) Watch liquidity
- In small/micro caps, check 3-month average daily traded value versus your order size. Avoid names where your trade would be >10–20% of ADV.
5) Use objective tripwires
- Example rules:
- If Turnover Velocity > 2× its 1-year median and breadth deteriorates for 4+ weeks, cut position by one-third.
- If 12M return > 2× 5-year CAGR while EPS is flat, move to neutral.
6) Diversify and rebalance
- Rebalance to target weights quarterly/half-yearly. This automatically sells some winners when crowds overpay.
- For HNIs: complement direct equities with PMS/AIF only after fee- and risk-adjusted evaluation; avoid chasing top-quartile past returns.
Real-world mini-scenarios (India)
- Small caps after a 2× run: Index delivers 100% in 12 months; EPS up 15%; P/E doubles. Expect volatility and a mean reversion—nibble, don’t chase. (Wright Research)
- New-age tech IPOs: Oversubscribed issues list weak; only those that hit profitability inflection later (e.g., strong unit economics) re-rate sustainably. (Reuters)
- Credit yield chase: When an AAA name surprises on default, crowded credit buckets gap wider; diversify issuer exposure and limit lower-rated paper. (Harvard Kennedy School)
FAQs
Is all herding bad?
No. When most investors have similar information (say, a rate cut), some co-movement is rational. The problem is blind imitation driven by stories, not data. (IMF)
How do I quantify crowding quickly?
Check P/E contribution to recent returns, breadth, and turnover velocity. If price is rising faster than earnings and fewer stocks lead the move, risk is elevated.
What about crypto FOMO for Indian investors?
Regulators have repeatedly flagged risks; policy is evolving with SEBI and RBI taking different tacks. Don’t extrapolate momentum without a risk budget. (Reuters)
What should I do if I realise I’ve chased a herd trade?
Shrink size, re-underwrite fundamentals, and set exit rules (e.g., partial profit-taking or a trailing stop). Rebalance back to your asset-allocation plan.
Bottom line for Indian investors
Herd behaviour shows up in every cycle—equities, IPOs, and even fixed income. Use evidence, position sizing, and process to avoid overpaying at peaks or panic-selling at lows. If you prefer a rules-based approach, start with our guides on [The Psychology of Market Cycles], [How Confirmation Bias Affects Investing], and [How to Read Stock Charts] for a full toolkit.
Sources: IMF (definition of herding); JPC report on the 1992 scam; Harvard/Quartz on IL&FS; Reuters/Mint/Fortune on IPOs and Adani; SEBI investor alerts. (IMF, Digital Sansad, Harvard Kennedy School, Quartz, Reuters, Fortune, The Times of India)