What is a Lemming?

A lemming is a disparaging term for an investor who exhibits herd mentality and invests without doing their own research, which often leads to losses.

Key Takeaways A lemming is a disparaging term for an investor who exhibits herd mentality and invests without doing their own research, which often leads to losses.

According to urban legend, lemmings are small rodents known for possessing instincts that cause them to, periodically, charge en masse off cliffs, with the end result being their death.

Conducting the necessary due diligence, or thinking like a contrarian, is a much better strategy than succumbing to lemming mentality, especially when irrational exuberance seems to have gripped the market.

Understanding Lemmings

According to urban legend, lemmings are small rodents known for possessing instincts that cause them to, periodically, charge en masse off cliffs, with the end result being their death. Metaphorically speaking, a lemming, in financial markets parlance, refers to an investor who is easily swayed by the irrationality of market price action that is prone to occur at the extremes, and jumps in for fear of missing out on, what they falsely believe, is a golden opportunity.

This "herd mentality," typically, increases the chance of losing money, because investors either leave the market too early or get into it too late when prices are already too high to make a profit. To counter the "herd mentality," many sophisticated investors, such as contrarian traders, react in an opposite manner when they sense that market movement is due to the influx of lemmings. For example, if investors are in a buying frenzy, contrarians will sell and when lemmings sells, these investors will buy instead.

To keep from becoming a lemming investor, one has to keep their emotions under control. In other words, separate from the analysis that is critical to placing a trade. An investor that is successful in doing this can, possibly, spot lemming activity and consider exploiting it for gains by moving in a contrarian fashion.

Conducting the necessary due diligence, or thinking like a contrarian, is a much better strategy than succumbing to lemming mentality, especially when irrational exuberance seems to have gripped the market. Extreme optimism often coincides with market tops and extreme pessimism is quite apparent at market bottoms. The obvious point is that these market extremes can only be factually identified after the fact. In other words, with the clarity that only come with hindsight.

Savvy investors know that the time to sell is when prices are much higher than fundamentals suggest and that the time to buy is when the prices are much lower than is reasonably warranted. Extreme optimism should be viewed in a bearish vein and extreme pessimism should be viewed as bullish, which is the opposite to the way a lemming thinks.

Studies have found that investors are most influenced by current events—market news, political events, earnings, etc.—and ignore long-term investment and economic fundamentals. Furthermore, if a movement starts in one direction, it tends to pick up more and more investors with time and momentum. The impact of such lemming-like behavior has been made worse in recent years due to an abundance of sensationalist financial, economic, and other news that bombard the sensibilities of investors. This proliferation of financial media inevitably affects investor psychology and gives birth to lemmings.

Strategies to Avoid Becoming a Lemming Investor