The Mystery of Market Movements: An Archetypal Approach to Investment Forecasting and Modelling

Chapter 5Existing Approaches to Capture Sentiments in Financial Markets, and Why They Do Not Work

Most existing methodologies that aim to capture investor sentiments in the financial markets are built on the theory of crowd psychology. This holds that a person in a collective will act differently from, and make decisions significantly different from, how they would think or behave as an individual—even so different that these acts could be in direct conflict. The foundation of crowd psychology assumes that people tend to give up their personal responsibility and surrender to the emotions of a crowd; they feel shielded by the anonymity of the crowd and abandon responsibility. A crowd may therefore assume a life of its own and drive people into behaviour they would otherwise not agree to and even condemn. Crowd psychology focuses on how a crowd as a single entity behaves and acts, as well as how it changes the perceptions of individuals entering the crowd.¹

Two theories are used to explain the different psychological mindsets of crowds and their individual components: the convergence theory and the contagion theory (or herding).²

According to the convergence theory, it is not the crowd itself that causes crowd behaviour; it is induced by specific individuals with leadership qualities. Thus the name “convergence”: the thought patterns and behaviour of individuals drawn to the crowd start to converge with those of the strong-minded leaders of the crowd. As such, crowd behaviour ...