Do you think you are smarter than the masses? How tempting it is to think that as individuals we can make better decisions than groups. In 2004 New Yorker columnist James Surowiecki released his book, The Wisdom of Crowds. The point he makes in the book is that large groups of independent decision makers are collectively smarter then individuals. Surowiecki raises a number of compelling points, and his argument holds water in the theoretical world. But we don’t live in a theoretical world.

I bring this up because in yesterday’s issue of Small Cap Investor Daily I wrote about the short-term inefficiency of markets and how I believe astute small-cap investors are well positioned to take advantage of market overreactions. To do this, individuals need to act counter to the trend. Or at least they need to lead the crowd by buying shares of companies after many others have sold them and driven the price down.  

The basis for individual advantage arises when groups of investors are all moving in the same direction, either simultaneously purchasing or simultaneously selling shares of the same stock because of publicly announced events. Often times, investors react more to what happens to the share price of the stock in question, then the actual event that causes the stock to move. In these situations, investors stop acting as individuals and begin acting as a crowd. At this point, individual decision making goes out the window, as does Surowiecki’s claim that crowds are smarter than individuals. Basically the crowd becomes a stupid mob.

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