The Effect of Behavioral Finance on Stock Investment Decisions

Herding

Herding occurs when individuals' private information is overwhelmed by the influence of public information about the decisions of a herd or group. Evidence of group influence in many financial decisions is consistent with bounded rationality. In an uncertain world, if we realize that our own judgment is fallible then it may be rational to assume that others are better informed and follow them Defined herding as a mutual imitation leading to a convergence of action, and Sias defined herding as investors' tendency to follow each other into and out of the same stocks so we can say that the herd behavior is the tendency individuals have to mimic the actions of a large group.

Kengatharan measured herding factor by using the following indicators:

1. Buying and selling decisions of other investors (Other investors' decisions of buying and selling stocks have impact on your investment decisions).
2. Choice of stock to trade of other investors (Other investors' decisions of choosing stock types have impact on your investment decisions).
3. Volume of stock to trade of other investors (Other investors' decisions of the stock volume have impact on your investment decisions).
4. Speed of herding (You usually react quickly to the changes of other investors' decisions and follow their reactions to the stock market).

A study titled: "Cross-Sectional Absolute Deviation Approach for Testing the Herd Behavior Theory: The Case of the ASE Index", was conducted by Dr. Imad Zeyad Ramadan, Associate Prof., Department of Finance, Applied Science University, Amman, Jordan. This study aimed to test whether the herd behavior appears in the Amman Stock Exchange (ASE). Using data on a daily basis for a sample of companies in the Free Float Share Weighted Index during the study period from the beginning of the 2000 to the end of August 2014 and using the Cross-Sectional Absolute Deviation (CSAD) Approach.

The results found that the non-linear relationship between the cross sectional absolute deviation of the stock returns and the return of the market portfolio is an inverse relationship (γ3=-0.179), so that the dispersion decreases with the increase in market rate of return, which means that investors during the study period were emulating the performance of the market without paying attention to the stock's characteristics regarding risk and return, which suggests that investors are taking the herd behavior.