We are naturally wired to follow the herd.
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Herds are built into human behavior, and the significant impact they can have on global asset markets is perfectly clear in the sharp volatility that cryptocurrencies repeatedly experience.
These digital assets experience bullish periods that include intense optimism and spectacular gains, followed by bearish periods characterized by panic selling and significant losses.
While there are certainly contrarian investors in the crypto industry, many market participants are joining the herd. This basically means that they follow the behavior of a broader group rather than doing their own analysis.
Scientists say gregarious behavior is universal in the animal kingdom, and humans are no exception.
One particularly striking example of how this affects our financial decisions is a development that market analysts often point to when explaining the wild rise in cryptocurrency prices. FOMO (fear of missing out).
Why is this behavior so ingrained? Several academics and other experts have considered this very issue and tried to outline the exact reasons why we have such a strong tendency to follow the herd.
A group that provides “safety and security”
Dr. Simon Moore, a Chartered Consumer Psychologist, highlighted practical reasons why people are so inclined to follow groups.
“Humans are social creatures, and that's why we tend to have social connections,” said Moore, chief psychologist and CEO of the London-based behavioral strategy agency IB. This was highlighted through comments received via email.
“Groups give us a sense of safety and security.Group membership also provides resources (from others in the group) and help and support (physical and psychological) from them. It also ensures that you increase your chances of getting ,” he said.
“Thus, humans generally give more weight to the actions and decisions of the majority (the inaccurate idea that if many people act or think this way, it's likely to be correct)” Moore he said.
Richard Lehman, adjunct professor of behavioral finance at the University of California, Berkeley Extension, echoed similar sentiments, stating that “grazing provides comfort to humans and is clearly an important driving force in our social lives today.'' ''.
“However, in finance and investing, it can have undesirable effects,” the expert, who is also the founder and director of BehavioralFinance.com, stressed in an email.
“It tends to make people blindly follow others and contributes to FOMO (fear of missing out), neither of which are considered rational reasons for investing in something specific,” he said. added.
“In extreme cases, herd behavior has been cited as a contributing factor to historic bubbles and crashes in stocks, tulips, and other commodities.”
useful shortcuts
David Nussbaum, now an adjunct associate professor of behavioral science at the University of Chicago Booth School of Business, gave us a practical explanation of why we tend to follow the herd.
“Humans are social animals, so it makes sense that we frequently rely on others to learn about the world,” he said in an emailed comment.
“It can often be a very useful strategy. If everyone else is doing it, there's probably a good reason for it, and it's unlikely to be dangerous. But there are big exceptions. There certainly is,” said Nussbaum, who teaches courses on power and influence at the business school.
“By paying attention to what others say and do, you can learn a lot about the right way to behave,” he emphasized.
“Whose behavior we pay attention to and what that tells us about us can also be very important,” the academic says, adding that there is more nuance to this matter. provided.
“For example, it makes sense to copy the behavior of people who look like us or whose identity we aspire to, but in the case of cryptocurrencies, it means you have to be bold and innovative. It doesn't make much sense to imitate someone you can't empathize with (if an adult comes to a child's birthday party and imitates the child's behavior rather than the parent's) “It's strange to do that,” he clarified.
“In summary, 'herding' – learning from and imitating the beliefs and behaviors of others – has many benefits and is a very common human instinct built on a long evolutionary history. “, Nussbaum concluded.
Buyer beware
Experts point out that following a larger group can be counterproductive, noting that “blindly following the actions of others and questioning why they believe or act the way they do ( and when they rarely stop to consider why others do it.” Doing so puts them at risk of chasing the herd off the edge of the cliff. ”
A good example of this would be an investor who bought Bitcoin just before the cryptocurrency reached an all-time high in late 2021.
At the time, the digital currency was worth more than $60,000 on CoinMarketCap, but has since fallen significantly, dropping below $17,000 in 2022.
The world's most famous digital currency has since recovered significantly, but investors who bought Bitcoin just before this peak have yet to recoup their losses.
Given stories like this, following the herd isn't always the best option.
Mr. Lehman spoke about this and provided further insight.
“Investing today can be complex and requires knowledge, expertise and data that many people don't have,” he said.
“Therefore, it is reasonable to seek advice from others,” Lehman continued.
“But it is an easy interpretation to think that there is wisdom in the behavior of crowds, and that is not always the case.”
Disclosure: I own some Bitcoin, Bitcoin Cash, Litecoin, Ether, EOS, and SOL.
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