For investors who use a trend following approach for managing their 401(k)s or IRAs, listening to conventional market wisdom can be perplexing. One of the more common axioms of conventional wisdom comes from market gurus who advise, “Don’t follow the herd!” Their reasoning is that blindly buying into a stock or a fund just because everyone else is “jumping on board” is a bad investment strategy. This bit of conventional wisdom at times flies in the face of trend following.
It is true that there are times when the ‘herd mentality’ can hurt investors:
- Mainly occurring with individual stocks or low volume ETFs, buyers all pile into a “hot” investment (usually too late in the cycle) only to see it collapse under its own weight.
- Investors who have “been on the sidelines” for an extended period of time finally decide to get back into stocks. They start buying into an aging bull market, only to see their bottom lines get crushed by the next bear market.
- Following the herd doesn’t just hurt buyers – it can hurt sellers, too. During the mad rush to get out of the market at the end of 2008 and early 2009, investors who joined that herd sold at the absolute worst time.
In these scenarios following the herd can be a bad investment move.
For trend followers, however, that herd mentality is what makes their portfolios grow. The reason is twofold.
1. The stock market goes up for one reason and one reason alone: there are more buyers than sellers, period.
2. Stocks and stock funds in 401(k) or IRAs portfolios only make money when the stock market is going up, period.
That means investors had better be following the herd during bull markets if they expect to boost their bottom lines… period.
Determining when to follow the herd and when to sit on the sidelines depends on the current major market trend. The easiest way to identify these trends is by looking at long-term market price charts. Charts reveal not only the current trend, but can also alert investors when that trend may be changing.
Trend followers realize that aligning their portfolios with the current major market trend is critical to getting the most out of their 401(k) or IRA investments. For that reason, they will often find themselves actually “following the herd.” The difference is they will not be blindly following the herd.
If you would like information on learning about price charts there are many excellent sources available across the internet.