The Madness of the Crowd

The Madness of the Crowd

The madness of the crowd can be truly spectacular. Many bad examples in investing, plus a host of others, have convinced more and more people to put their money under the care of a professional – someone who knows what makes the market tick and who can be trusted to act prudently.

What are memories so short? Why do such speculative crazes seem so isolated from the lessons of history? I have no apt answer to offer, but I am convinced that Bernard Baruch was correct in suggesting that a study of these events can help equip investors for survival. The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze. It is not hard, really, to make money in the market. Investors who select stocks by throwing darts at the stock listings in the Wall Street Journal can make fairly handsome long-run returns. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges.

And yet the melody lingers on. I have a good friend who once built a modest stake into a small fortune. Then along came a stock called Alphanumeric. In addition to offering an exciting name, it also promised to revolutionize the method of feeding data into computers. My friend was hooked.

Madness of invisible crowd. Photo by Elena

I begged him to investigate first whether the huge future earnings that were already reflected in the price could possibly be achieved given the likely size of the market (of course, the company had no current earnings). He thanked me for my advice but dismissed it by saying that stock prices weren`t based on “fundamentals” like earnings and dividends. “The history of stock valuation bears me out. This Alphanumeric story will have all the tape watchers drooling with excitement and conjuring up visions of castles in the air. Any delay in buying would be self-defeating”. And so my friend had to rush in before the crowd could bid up the price.

And rush in he did, buying at $80, which was close to the peak of a craze in that particular stock. The stock plunged to $2, and with it my friend`s fortune – which became much more modest than what he originally started out with. The ability to avoid such horrendous mistakes is probably the most important factor in preserving one`s capital and allowing it to grow. The lesson is so obvious and yet so easy to ignore.

The madness of the crowd, as we have just seen, can be truly spectacular. The bad examples, I have just cited, plus a host of others, have convinced more and more people to put their money under the care of a professional – someone who knows what makes the market tick and who can be trusted to act prudently.

Sources:

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.