Why Do We Tend To Follow The Herd?
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We are naturally wired to follow the herd.
Herding is hardwired into human behavior, and the profound impact it can have on the global asset markets is perfectly evident in the sharp volatility repeatedly experienced by cryptocurrencies.
These digital assets undergo bullish periods that can include wild optimism and eye-popping gains, and then suffer bearish periods characterized by panic selling and significant losses.
While there are certainly contrarian investors in the cryptocurrency space, many market participants take part in herding, which basically means they follow the actions of the broader group instead of conducting their own analysis.
Scientists have described herding behavior as being universal in the animal kingdom, with people being no exception.
One particularly striking example of how this affects our financial decision-making is FOMO (fear of missing out), a development that market analysts frequently point to when explaining intense rallies in cryptocurrency prices.
Why is this behavior so ingrained? Several academics and other experts weighed in on this very question, seeking to outline the exact reasons we have such a strong tendency to follow the herd.
Groups Offer ‘Safety And Security’
Dr. Simon Moore, a Charted Consumer Psychologist, highlighted a practical reason why people display such a strong tendency toward following groups.
“Humans are social creatures – as such we are predisposed to social connectivity,” Moore, who serves as chief psychologist & CEO of London-based behavioral strategy agency IB, emphasized through comments submitted via email.
“Groups offer us the perception of safety and security – group membership also ensures that we increase our potential for resources (from others in the group) as well as help and support from them (both physical and psychological),” he noted.
“So humans generally give weighting to the actions and decisions of the majority (thinking inaccurately that if many people act or think this way it is more likely to be correct),” said Moore.
Richard Lehman, an adjunct professor of Behavioral Finance at UC Berkeley Extension, offered a similar take, stating that “Herding offers human comforts and is clearly a key driver in our social lives today.”
“In finance and investing, however, it can have undesirable effects,” the expert, who also serves as the founder and educator-in-chief of BehavioralFinance.com, stressed via email.
“It tends to cause people to blindly follow others and it contributes to FOMO — the fear of missing out — neither of which are considered rational reasons to invest in certain things,” he added.
“At the extremes, herding behavior is cited as a contributing factor to historic bubbles and crashes in stocks, tulips, and other such items.”
A Useful Shortcut
David Nussbaum, who currently works as an adjunct associate professor of Behavioral Science at the University of Chicago Booth School of Business, offered a practical explanation for why we tend to follow the herd.
“Humans are a social animal, so it makes sense that they frequently turn to others to learn about the world,” he stated via emailed comments.
“It can often be a very useful strategy — if everyone else is doing it, there’s probably a good reason, and it’s not likely to be dangerous — although there are certainly major exceptions,” noted Nussbaum, who teaches a course on Power and Influence at the business school.
“By paying attention to what others say and do we can learn a lot about the right ways to behave,” he emphasized.
“It can also matter a lot whose behavior we’re paying attention to and what it says about us,” the academic stated, offering further nuance on the subject.
“For example, it can make sense to copy the behavior of people who are similar to us, or have an identity we aspire to — for crypto I would imagine what you think it says about is that you’re bold and innovative — but much less sense to copy people we don’t identify with (it would be strange for an adult to come to a children’s birthday party and copy the behavior of the kids rather than the parents),” he clarified.
“In sum, there are a lot of benefits to ‘herding’ — to learning from and copying others beliefs and behavior — and it’s a very common human instinct that builds on a long evolutionary history,” Nussbaum concluded.
Buyer Beware
The expert pointed out that following a larger group can be counterproductive, noting that “if you blindly follow the behavior of others and rarely pause to reflect on why you believe what you do or act the way you’re acting (and why others may be doing so) you put yourself at risk of following the herd off the edge of a cliff.”
A perfect example of this would be investors who bought bitcoin shortly before the cryptocurrency reached an all-time high in late 2021.
While the digital currency was worth more than $60,000 on CoinMarketCap at the time, it came down quite a bit after that, falling below $17,000 in 2022.
While the world’s most prominent digital currency has recovered significantly since then, investors who purchased bitcoin shortly before this pinnacle have still not recouped their losses.
In light of stories like these, following the herd is not always the best option.
Lehman spoke to this, offering further insight.
“Present day investing can be complicated and requires knowledge, expertise, and data that many people do not have,” he noted.
“Therefore, seeking advice from others is a rational thing to do,” Lehman continued.
“But it is an easy stretch to assume there is wisdom in the crowd’s actions and that is not always the case.”
Disclosure: I own some bitcoin, bitcoin cash, litecoin, ether, EOS and SOL.