The term “lemming” refers to an investor who follows the crowd’s lead. A common type of lemming is an individual investor that enters and exits the market depending on whether prices have recently risen or fallen.
In contrast to lemmings, contrarian investors enjoy trading against the grain. While other people are active, they tend to sit on the sidelines and purchase when everyone else is selling. As a result, the contrarian typically invests in low-cost security that everyone else considers a dud while simultaneously selling a security that everyone else wants to purchase.
At times when prices are far above fundamentals or far below reasonable levels, smart investors recognize that it’s time to sell or time to buy. Lemmings are either over-optimistic or over-pessimistic in their decision-making.
You should never allow your emotions to interfere with your trading decisions. You may, however, use the fear and greed of the masses to your advantage. To profit from market psychology, you must operate in a counter-intuitive manner, going against the crowd’s instincts.
The effects of lemming
In general, this “herd mentality” raises the risk of losing money since investors either exit or enter the market at the wrong time. To offset the “herd mentality,” many intelligent investors respond in the other direction when they believe the market action is due to an invasion of lemmings.
As an example, if investors are in a purchasing rush, smart investors will sell, and when lemmings sell, these investors will purchase instead.
Strategies for preventing lemming
Have a strategy in place
Failing to plan is planning to fail. When it comes to making money in financial markets, you need to have a well-thought-out strategy in place. Performance evaluation and determining whether you are on the right or wrong road are critical to assessing your progress.
Define your risk level
One of the reasons why some investors are easily swayed by others’ opinions is because of the lack of a well-defined risk management strategy.
In the absence of a strategy defining the maximum risk you are willing to take, you can easily find yourself taking more risk than you can manage, especially when market sentiment and news indicate that many investors are following a particular trend. A risk management strategy ensures that you stick to your trading and ensures that your decision-making is informed by facts and not greed.
Automate your trade
One of the most effective ways of eliminating emotional interference with trading is by integrating automation in your trading. This typically involves using expert advisors (EAs) or robots to execute your trades. With this type of approach, you can either use a fully-automated signal provider or a semi-automated provider.
In case you opt for a fully-automated service, the robot will not only identify appropriate entry and exit positions but also initiate the trades. In case you use a semi-automated EA, the service provider will send you signals on the appropriate positions to take, but the decision on whether or not to take those positions will be at your discretion.
Use social trading
Social trading is an approach to trading whereby traders can learn from each other’s strategies. On trading platforms that have social trading features, experienced traders often share the strategies used to execute their trades.
If you are a trader and you are unsure about the strategy to use, you can learn from other traders by borrowing their strategies. The beauty of social trading platforms is that you can always compare the strategies of different traders and pick one that is in line with your objectives or personality.
Social trading is a far much better option to blind decision-making that is characteristic of lemming. The strategies employed have good reasoning behind them, ensuring that you make a well-informed decision.
Keep to your investing strategy
You should stick to a certain investment strategy or signal until there are compelling reasons to do otherwise. An investment strategy’s success is often dependent on the market’s overall performance over time.
Since nervous investors tend to quit strategies that are momentarily out of favor just before they make a significant comeback, moving between strategies may be a challenge.
People tend to focus on recent events rather than long-term investing and economic fundamentals, such as political events and earnings releases. It is also common for investors to join a price trend that is headed in a certain direction as it gains pace.
Lemming-like behavior is worsened by the fact that financial and economic news impacting investor emotions travels quicker than ever before.
The ability to move capital between countries has improved greatly, allowing international markets to react more swiftly to abrupt shifts in the direction of investor buying and selling.
In summary
Lemmings are investors who are easily swept away by the unpredictability of market price movement, which is prone to occur at extremes, and who jump out of fear of losing out on a profitable investment opportunity in the financial markets.
As a result of this “herd mentality,” investors are more likely to miss out on profits because they either exit or enter the market at the wrong time.
Emotions must be kept under control in order to prevent becoming a lemming. In other words, aside from the analysis that is required to make a trade, you need to be steadfast in your strategy to avoid being swayed by short-time turbulence. A smart investor may be able to notice lemming behavior and consider leveraging it for profit in the other direction.
