A classic book on mass psychology offers invaluable lessons for investors
If the stock market is a crowd, then a study of crowds becomes essential for the thoughtful investor. Out of many books that have been written on the subject, if you read only four, you will get the finest instruction in contrary investing available anywhere in the world. These books are: (1) Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay; (2) The Great Crash 1929, by John Kenneth Galbraith; (3) A Short History of Financial Euphoria, by John Kenneth Galbraith; and (4) The Crowd: A Study of Popular Mind, by Gustave Le Bon.
In this week's column, I will focus on The Crowd, by Gustave Le Bon. Le Bon, a brilliant Frenchman wrote The Crowd one hundred years ago, in 1896. This book, originally published in French, but later translated into English has been reprinted dozens of times. One of the most remarkable things about it is that the words "investment," "market," "dividend," "earnings" or even "cash" do not appear in it. Not even once. (I checked.) Le Bon did not write this book with investors in mind. And yet, this book gives extraordinarily valuable lessons to investors who have a deep desire to improve their investment performance. It's not surprising that many bookstores keep this book in the Investment section.
Here are a few extracts from this classic book with my comments in words surrounded by brackets:
General Characteristics of Crowds
In its ordinary sense the word "crowd" means a gathering of individuals of whatever nationality, profession, or sex, and whatever be the chances that have brought them together. From the psychological point of view the expression "crowd" assumes quite a different signification. Under certain given circumstances, and only under those circumstances, an agglomeration of men presents new characteristics very different from those of the individuals composing it. The sentiments and ideas of all the persons in the gathering take one and the same direction, and their conscious personality vanishes. A collective mind is formed, doubtless transitory, but presenting very clearly defined characteristics. The gathering has thus become what, in the absence of a better expression, I will call an organised crowd, or, if the term is considered preferable, a psychological crowd. It forms a single being, and is subjected to the law of the mental unity of crowds.
It is evident that it is not by the mere fact of a number of individuals finding themselves accidentally side by side that they acquire the character of an organised crowd. A thousand individuals accidentally gathered in a public place without any determined object in no way constitute a crowd from the psychological point of view. To acquire the special characteristics of such a crowd, the influence is necessary of certain predisposing causes of which we shall have to determine the nature.
The disappearance of conscious personality and the turning of feelings and thoughts in a definite direction, which are the primary characteristics of a crowd about to become organised, do not always involve the simultaneous presence of a number of individuals on one spot. Thousands of isolated individuals may acquire at certain moments, and under the influence of certain violent emotions - such, for example, as a great national event - the characteristics of a psychological crowd. [this thesis applies to modern stock exchanges where computers have replaced the crowd on the trading floor. Crowds, as Le Bon points out can exist amongst isolated people. The death of the trading floor, has not resulted in the absence of crowd mentality in the stock market.] It will be sufficient in that case that a mere chance should bring them together for their acts to at once assume the characteristics peculiar to the acts of a crowd. At certain moments half a dozen men might constitute a psychological crowd, which may not happen in the case of hundreds of men gathered together by accident. On the other hand, an entire nation, though there may be no visible agglomeration, may become a crowd under the action of certain influences. [this happens, for example, when there is a war, or when India plays Pakistan in a Cricket match or when we have a big bull market.]
The most striking peculiarity presented by a psychological crowd is the following: Whoever be the individuals that compose it, however like or unlike be their mode of life, their occupations, their character, or their intelligence, the fact that they have been transformed into a crowd puts them in possession of a sort of collective mind which makes them feel, think, and act in a manner quite different from that in which each individual of them would feel, think, and act were he in a state of isolation. There are certain ideas and feelings which do not come into being, or do not transform themselves into acts except in the case of individuals forming a crowd. [For example, people who resort to violence in communal riots, are not hardened criminals. They are ordinary people like you and me. But a violent crowd has a mind of its own. As part of a violent crowd, a man will do things, he would never have done, if he was isolated. History is full of examples that prove this point.]
In the collective mind the intellectual aptitudes of the individuals, and in consequence their individuality, are weakened. The heterogeneous is swamped by the homogeneous, and the unconscious qualities obtain the upper hand.
This very fact that crowds possess in common ordinary qualities explains why they can never accomplish acts demanding a high degree of intelligence. The decisions affecting matters of general interest come to by an assembly of men of distinction, but specialists in different walks of life, are not sensibly superior to the decisions that would be adopted by a gathering of imbeciles. The truth is, they can only bring to bear in common on the work in hand those mediocre qualities which are the birthright of every average individual. In crowds it is stupidity and not mother-wit that is accumulated. [The last sentence in this paragraph has been quoted by many outstanding investors, including Warren Buffett. These superinvestors believe that to succeed in business as well as in investing one has to think like a contrarian.]
In a crowd every sentiment and act is contagious, and contagious to such a degree that an individual readily sacrifices his personal interest to the collective interest. This is an aptitude very contrary to his nature, and of which a man is scarcely capable, except when he makes part of a crowd.
We know to-day that by various processes an individual may be brought into such a condition that, having entirely lost his conscious personality, he obeys all the suggestions of the operator who has deprived him of it, and commits acts in utter contradiction with his character and habits. The most careful observations seem to prove that an individual immerged for some length of time in a crowd in action soon finds himself - either in consequence of the magnetic influence given out by the crowd, or from some other cause of which we are ignorant - in a special state, which much resembles the state of fascination in which the hypnotised individual finds himself in the hands of the hypnotiser. The activity of the brain being paralysed in the case of the hypnotised subject, the latter becomes the slave of all the unconscious activities of his spinal cord, which the hypnotiser directs at will. The conscious personality has entirely vanished; will and discernment are lost. All feelings and thoughts are bent in the direction determined by the hypnotiser. [It was a hypnotised crowd that Harshad Mehta controlled in 1992, when he led thousands of Indians to believe that stock prices will keep rising forever and ever. We all know the result.]
Such also is approximately the state of the individual forming part of a psychological crowd. He is no longer conscious of his acts. In his case, as in the case of the hypnotised subject, at the same time that certain faculties are destroyed, others may be brought to a high degree of exaltation. Under the influence of a suggestion, he will undertake the accomplishment of certain acts with irresistible impetuosity. [For example, by buying stocks at crazy prices, as thousands of Indians did in 1992 and 1994.] This impetuosity is the more irresistible in the case of crowds than in that of the hypnotised subject, from the fact that, the suggestion being the same for all the individuals of the crowd, it gains in strength by reciprocity. The individualities in the crowd who might possess a personality sufficiently strong to resist the suggestion are too few in number to struggle against the current.
We see, then, that the disappearance of the conscious personality, the predominance of the unconscious personality, the turning by means of suggestion and contagion of feelings and ideas in an identical direction, the tendency to immediately transform the suggested ideas into acts; these, we see, are the principal characteristics of the individual forming part of a crowd. He is no longer himself, but has become an automaton who has ceased to be guided by his will.
Moreover, by the mere fact that he forms part of an organised crowd, a man descends several rungs in the ladder of civilisation. Isolated, he may be a cultivated individual; in a crowd, he is a barbarian - that is, a creature acting by instinct. [Remember, November 1984 riots after Indira Gandhi's assassination? Or the 1992 riots in Bombay?] He possesses the spontaneity, the violence, the ferocity, and also the enthusiasm and heroism of primitive beings, whom he further tends to resemble by the facility with which he allows himself to be impressed by words and images - which would be entirely without action on each of the isolated individuals composing the crowd - and to be induced to commit acts contrary to his most obvious interests and his best-known habits. An individual in a crowd is a grain of sand amid other grains of sand, which the wind stirs up at will.
It is for these reasons that juries are seen to deliver verdicts of which each individual juror would disapprove, that parliamentary assemblies adopt laws and measures of which each of their members would disapprove in his own person. Taken separately, the men of the Convention were enlightened citizens of peaceful habits. United in a crowd, they did not hesitate to give their adhesion to the most savage proposals, to guillotine individuals most clearly innocent, and, contrary to their interests, to renounce their inviolability and to decimate themselves.
It is not only by his acts that the individual in a crowd differs essentially from himself. Even before he has entirely lost his independence, his ideas and feelings have undergone a transformation, and the transformation is so profound as to change the miser into a spendthrift, the sceptic into a believer, the honest man into a criminal, and the coward into a hero.
The conclusion to be drawn from what precedes is, that the crowd is always intellectually inferior to the isolated individual, but that, from the point of view of feelings and of the acts these feelings provoke, the crowd may, according to circumstances, he better or worse than the individual. All depends on the nature of the suggestion to which the crowd is exposed. This is the point that has been completely misunderstood by writers who have only studied crowds from the criminal point of view. Doubtless a crowd is often criminal, but also it is often heroic. It is crowds rather than isolated individuals that may be induced to run the risk of death to secure the triumph of a creed or an idea, that may be fired with enthusiasm for glory and honour, that are led on - almost without bread and without arms, as in the age of the Crusades - to deliver the tomb of Christ from the infidel, or, as in '93, to defend the fatherland. Such heroism is without doubt somewhat unconscious, but it is of such heroism that history is made. Were peoples only to be credited with the great actions performed in cold blood, the annals of the world would register but few of them. [For example, India may not have achieved its independence were it not for a handful of leaders who had the ability to hypnotise crowds.]
Impulsiveness of Crowds
When studying the fundamental characteristics of a crowd we stated that it is guided almost exclusively by unconscious motives. Its acts are far more under the influence of the spinal cord than of the brain. In this respect a crowd is closely akin to quite primitive beings. The acts performed may be perfect so far as their execution is concerned, but as they are not directed by the brain, the individual conducts himself according as the exciting causes to which he is submitted may happen to decide. A crowd is at the mercy of all external exciting causes, and reflects their incessant variations. It is the slave of the impulses which it receives. [For example, many people find it very hard to resist trading on rumours that are constantly floating around in the marketplace.] The isolated individual may be submitted to the same exciting causes as the man in a crowd, but as his brain shows him the inadvisability of yielding to them, he refrains from yielding. This truth may be physiologically expressed by saying that the isolated individual possesses the capacity of dominating his reflex actions, while a crowd is devoid of this capacity. [That's precisely why it pays to be completely detached from the market. To quote Warren Buffett: "If you can detach yourself from the emotions of the market, you are going to get a chance periodically to do something intelligent - not very often, but periodically." ]
The Suggestibility and Credulity of Crowds.
When defining crowds, we said that one of their general characteristics was an excessive suggestibility, and we have shown to what an extent suggestions are contagious in every human agglomeration; a fact which explains the rapid turning of the sentiments of a crowd in a definite direction. However indifferent it may be supposed, a crowd, as a rule, is in a state of expectant attention, which renders suggestion easy. The first suggestion formulated which arises implants itself immediately by a process of contagion in the brains of all assembled, and the identical bent of the sentiments of the crowd is immediately an accomplished fact.
As is the case with all persons under the influence of suggestion, the idea which has entered the brain tends to transform itself into an act. Whether the act is that of setting fire to a palace, or involves self-sacrifice, a crowd lends itself to it with equal facility. All will depend on the nature of the exciting cause, and no longer, as in the case of the isolated individual, on the relations existing between the act suggested and the sum total of the reasons which may be urged against its realisation.
In consequence, a crowd perpetually hovering on the borderland of unconsciousness, readily yielding to all suggestions, having all the violence of feeling peculiar to beings who cannot appeal to the influence of reason, deprived of all critical faculty, cannot be otherwise than excessively credulous. The improbable does not exist for a crowd, and it is necessary to bear this circumstance well in mind to understand the facility with which are created and propagated the most improbable legends and stories.
Such is always the mechanism of the collective hallucinations so frequent in history - hallucinations which seem to have all the recognised characteristics of authenticity, since they are phenomena observed by thousands of persons. [One of the classic cases of millions of Indians hallucinating together occurred in September 1995, when they "saw with their own eyes" idols of Lord Ganesh drink milk in temples all over India and abroad. Of course, keen students of financial history will remember many other instances where millions have lost their money by believing outrageous stories. One such example is quite recent - the primary market episode of 1993-94, when people actually believed that the market will continue to place very high valuations on new ventures floated by unknown promoters with no credentials.]
To return to the faculty of observation possessed by crowds, our conclusion is that their collective observations are as erroneous as possible, and that most often they merely represent the illusion of an individual who, by a process of contagion, has suggestioned his fellows. [meaning that the crowd is often wrong and, therefore, it pays to be contrary.]
The exaggeration and ingenuousness of the sentiments of crowds
Whether the feelings exhibited by a crowd be good or bad, they present the double character of being very simple and very exaggerated. On this point, as on so many others, an individual in a crowd resembles primitive beings. Inaccessible to fine distinctions, he sees things as a whole, and is blind to their intermediate phases. The exaggeration of the sentiments of a crowd is heightened by the fact that any feeling when once it is exhibited communicating itself very quickly by a process of suggestion and contagion, the evident approbation of which it is the object considerably increases its force. [which is why markets move from one extreme to the other.]
Unfortunately, this tendency of crowds towards exaggeration is often brought to bear upon bad sentiments. These sentiments are atavistic residuum of the instincts of the primitive man, which the fear of punishment obliges the isolated and responsible individual to curb. Thus it is that crowds are so easily led into the worst excesses.
Given to exaggeration in its feelings, a crowd is only impressed by excessive sentiments. An orator wishing to move a crowd must make an abusive use of violent affirmations. To exaggerate, to affirm, to resort to repetitions, and never to attempt to prove anything by reasoning are methods of argument well known to speakers at public meetings. [including politicians. One famous Indian politician won his parliamentary seat by promising farmer voters that, if elected, he will make sure they get irrigation water from which the electricity has not been removed by a hydro-electric power station.]
I need not add that the tendency to exaggeration in crowds is only present in the case of sentiments and not at all in the matter of intelligence. I have already shown that, by the mere fact that an individual forms part of a crowd, his intellectual standard is immediately and considerably lowered.
The Reasoning Power of Crowds
The inferior reasoning of crowds is based, just as is reasoning of a high order, on the association of ideas, but between the ideas associated by crowds there are only apparent bonds of analogy or succession. The mode of reasoning of crowds resembles that of the Esquimaux who, knowing from experience that ice, a transparent body, melts in the mouth, concludes that glass, also a transparent body, should also melt in the mouth; or that of the savage who imagines that by eating the heart of a courageous foe he acquires his bravery; or of the workman who, having been exploited by one employer of labour, immediately concludes that all employers exploit their men.
A chain of logical argumentation is totally incomprehensible to crowds, and for this reason it is permissible to say that they do not reason or that they reason falsely and are not to be influenced by reasoning.
It would be superfluous to add that the powerlessness of crowds to reason aright prevents them displaying any trace of the critical spirit, prevents them, that is, from being capable of discerning truth from error, or of forming a precise judgement on any matter. Judgements accepted by crowds are merely judgements forced upon them and never judgements adopted after discussion.
Crowds are not to be influenced by reasoning, and can only comprehend rough-and-ready associations of ideas. The orators who know how to make an impression upon them always appeal in consequence to their sentiments and never to their reason. The laws of logic have no action on crowds.
Fixed Beliefs of Crowds
The opinions and beliefs of crowds may be divided, then, into two very distinct classes. On the one hand we have great permanent beliefs, which endure for several centuries .[for example, the fixed belief that gold and real estate are, and will remain to be the most profitable investments.] In the second place, there are the transitory, changing opinions. Opinions of this order are as superficial, as a rule, as fashion, and as changeable. [for example, fads and fashions in the stock market.] They may be compared to the ripples which ceaselessly arise and vanish on the surface of a deep lake.
It is easy to imbue the mind of crowds with a passing opinion, but very difficult to implant therein a lasting belief. However, a belief of this latter description once established, it is equally difficult to uproot it. It is usually only to be changed at the cost of violent revolutions. [or a big market crash.]
Conclusion
In this excellent work, Le Bon shows the basic distinction between a crowd and an individual. Whereas an individual may act after reasoning and analysis, a crowd acts on feelings, sentiments, and emotions. In the case of markets, these are fear and greed, euphoria and hysteria.
According to Le Bon, a crowd, is susceptible to "contagion." This means that if an idea attracts a few people, it is likely to spread, and soon attract numbers of crowds.
Because a crowd does not think, but acts on impulses, public opinions are frequently wrong. By the same token, because a crowd is carried away by feeling, or sentiment, you will find the public participating enthusiastically in various manias after the mania has got well under momentum. This happens frequently in the stock market. Irrationally, the crowd - that is, the public - will remain indifferent when prices are low. Equally, irrationally, the public is attracted by rising prices. It is simply due to crowd mentality that many fools are parted from their money because they were tempted into the market by a price manipulator who made a sleepy stock active and pushed its price higher.
If you observe the behaviour of successful investors, you will find that invariably they have a completely independent mind. They think alone and act alone. And they keep far away from the stock market. Many of them work a long way from any major financial centre. Once Warren Buffett was asked, why he did not operate from New York instead of a small town, Omaha, which is several hundred miles away from the nearest stock exchange. His reply was instructive. He said, "Well, we have telephones here, and we get all the newspapers. What we don't have is a hundred people coming upstairs everyday, and whispering in our ears, that we should be doing this, or that, this afternoon."
If you study the performance of mutual funds, again you will find, that the best performing mutual funds, don't have an investment committee deciding upon critical asset allocation or security selection decisions. These decisions are left to one competent person who is completely in charge. His decisions, are his own. He reports directly to the shareholders and not to any investment committee or board of directors. Since boards of directors or investment committees are also crowds, we find, that their power of reasoning is rather non-existent. I am reminded of an investment committee in UTI who made the famous decision of investing Rs 1,000 crore in Reliance Industries at Rs 385 per share. Was that investment committee reasoning? I think not. The behaviour of this investment committee reminds me of a remark made by Warren Buffett: "It is close to impossible for outstanding investment management to come from a group of any size. My idea of a group decision is to look in the mirror."
The Crowd: A Study of Popular Mind, is available with Fraser Publishing, Box 494, Burlington, VT 05402, USA. Telephone: 802-658-0260. It costs $9.95. If you have access to the Internet, you can download a text version for free from the reading room of the Internet Public Library at http://ipl.sils.umich.edu
Note
This article is submitted by Sanjay Bakshi who is the Chief Executive Officer of a New Delhi based company called Corporate Investment Research Private Limited.
© Sanjay Bakshi. 1997.