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Why do we tend to follow the herd?
We are naturally programmed to follow the herd.
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Herding is an integral part of human behavior and the profound impact it can have on global financial markets is perfectly evident in the strong volatility repeatedly experienced by cryptocurrencies.
These digital assets go through bullish periods that can include unbridled optimism and eye-popping gains, and then undergo 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 essentially 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, and people are no exception.
A particularly striking example of how this affects our financial decision-making is FOMO (fear of missing out), a development that market analysts often point to when explaining intense cryptocurrency price increases.
Why is this behavior so ingrained? Several academics and other experts have weighed in on this very question, trying to outline the exact reasons why we have such a strong tendency to follow the herd.
Groups Offer “Safety and Protection”
Dr. Simon Moore, a recognized consumer psychologist, highlighted a practical reason why people show such a strong tendency to follow groups.
“Humans are social creatures: as such we are wired for social connectivity,” Moore, who serves as chief psychologist and managing director of the London-based behavioral strategy agency IBhighlighted through comments sent 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 weight to the actions and decisions of the majority (mistakenly thinking that if many people act or think this way it is more likely to be correct),” Moore said.
Richard Lehman, Adjunct Professor of Behavioral Finance at UC Berkeley Extensionoffered a similar view, stating that “Herding offers human comforts and is clearly a key factor in our social life today.”
“In finance and investments, however, it can have undesirable effects,” the expert, who is also the founder and chief trainer of Behavioral Finance.comunderlined via email.
“It tends to cause people to blindly follow others and contributes to FOMO – the fear of missing out – neither of which is considered a rational reason to invest in certain things,” he added.
“At the extremes, shepherding behavior is cited as a contributing factor to historic bubbles and crashes in stocks, tulips and other similar assets.”
A useful shortcut
David Nussbaum, who currently jobs as adjunct associate professor of Behavioral Sciences at the Booth School of Business at the University of Chicagooffered a practical explanation for why we tend to follow the herd.
“Humans are social animals, so it makes sense that they often turn to others to learn about the world,” he said 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 important exceptions,” noted Nussbaum, who teaches a course on Power and influence at 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 who we pay attention to and what it says about us,” the academic said, offering further nuance on the topic.
“For example, it may make sense to copy the behavior of people who are similar to us, or who have an identity that we aspire to – for cryptocurrencies I guess what you think is that you are bold and innovative – but it makes much less sense to copy people which we do not identify with (it would be strange for an adult to come to a children’s birthday party and copy the behavior of the children instead of the parents),” he clarified.
“In summary, there are many benefits to ‘grazing’ – learning and copying the beliefs and behaviors of others – and it is a very common human instinct that is based on a long evolutionary history,” concluded Nussbaum.
Buyer beware
The expert stressed that following a larger group can be counterproductive, stressing that “if you blindly follow the behavior of others and rarely stop to reflect on why you believe what you do or act the way you do (and why others they might be by 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 purchased bitcoin just before the cryptocurrency hit an all-time high in late 2021.
While the digital currency was worth more than $60,000 CoinMarketCap at the time, it later fell quite a bit, falling below $17,000 in 2022.
While the world’s top digital currency has since recovered significantly, investors who bought bitcoin shortly before reaching this peak have yet to recoup their losses.
In light of stories like these, following the herd isn’t always the best solution.
Lehman talked about it, offering further insights.
“Investing today can be complicated and requires knowledge, skills and data that many people don’t have,” he noted.
“Therefore, seeking advice from others is a rational thing to do,” Lehman continued.
“But it’s easy to assume there is wisdom in the actions of the crowd and that’s not always the case.”
Disclosure: I own bitcoin, bitcoin cash, litecoin, ether, EOS and SOL.