Much has been written about crowd and group behavior in the investment industry, but one aspect that has received little attention is what has been called ‘emotional contagion.’ As the term suggests, people can infect each other behaviorally, and in the investment sector, that can cost everyone a lot of money.

The term ‘contagion’ is accurate in the context of investment because it frequently leads to irrational or impudent behavior. Contagion prevents ‘healthy’ evaluations of investment opportunities, and gets in the way of sound judgment in decision making.

Contagion leads to the classic blunders associated with following the crowd – buying into the market when prices are high, and fleeing in panic when the prices drop. Contrarian behavior, generally the safest way to make money, is completely undermined by emotional contagion.

Emotional contagion is common because people tend to imitate those who seem to be successful. Envy and greed attract others into the same activities. The problem is that by the time contagion sets in when it comes to ordinary people investing, it is usually too late in the cycle to make money. Prices and the risks of a crash are too high at that stage.

So how do we overcome this contagion? The key is emotional neutrality – only invest for coldly rational reasons, and never because other people are buying and making money at the moment. Heated emotions, euphoria, and excitement are the enemy of prudent and profitable investing. Make sure you don’t get carried away with the crowd. In fact, it is almost always best to do just the opposite. When the crowd is cheering and buying, look to sell; when it is moaning, groaning, panicking and selling, it is generally time to make your move.

View a previously written post by Mouli Cohen about emotional investing