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Why do we tend to follow the herd?
We are naturally programmed to follow the herd.
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Herd behavior is ingrained in human behavior, and the profound impact it can have on global asset markets is abundantly evident in the high volatility that cryptocurrencies repeatedly experience.
These digital assets go through bullish periods that can include wild optimism and eye-popping gains, then suffer bearish periods characterized by panic selling and significant losses.
While there are certainly contrarian investors in the cryptocurrency space, many market participants participate in the herd, which essentially means they follow the actions of the broader group instead of conducting their own. analysis.
Scientists have described herd behavior as be universal in the animal kingdom, humans being no exception.
A particularly stark example of how this affects our financial decision-making is FOMO (fear of missing out), a development that market analysts frequently point to as an explanation for intense cryptocurrency price rises.
Why is this behavior so ingrained? Several academics and other experts have looked into this very question, seeking to describe the exact reasons why we have such a strong tendency to follow the herd.
Groups offer “safety and security”
Chartered consumer psychologist Dr Simon Moore has highlighted a practical reason why people display such a strong tendency to follow groups.
“Humans are social creatures – as such we are predisposed to social connectivity,” Moore, chief psychologist and CEO of the London-based behavioral strategy agency. BIhighlighted through comments submitted by email.
“Groups provide us with a perception of safety and security – membership in a group also ensures that we increase our resource potential (from other group members) as well as their help and support (both physical and psychological) “, he noted.
“So humans generally give weight to the actions and decisions of the majority (wrongly thinking that if many people act or think that way, they are more likely to be correct),” Moore said.
Richard Lehman, assistant professor of behavioral finance at UC Berkeley Extensionoffered a similar view, stating that “livestock farming provides human comfort and is clearly a key driver in our social life today. »
“On the other hand, in the field of finance and investment, this can have undesirable effects,” believes the expert, who is also founder and chief educator of Behavioral Finance.compointed out via email.
“This 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, herd behavior is cited as a contributing factor to historical bubbles and crashes in stocks, tulips, and other similar commodities. »
A useful shortcut
David Nussbaum, who currently works as an adjunct associate professor of behavioral sciences at the University of Chicago Booth School of Businessoffered 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 said in emailed comments.
“This can often be a very useful strategy — if everyone is doing it, there’s probably a good reason, and it probably won’t 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 good behavior,” he emphasized.
“What behavior we pay attention to and what it says about us can also be very important,” the academic said, offering more nuance on the subject.
“For example, it might make sense to copy the behavior of people who look like us or who have an identity that we aspire to – for crypto, I guess what that means, in your opinion, is that you are bold and innovative – but much more. It makes less sense to copy people we don’t identify with (it would be strange if an adult came to a children’s birthday party and copied the children’s behavior rather than the parents’),” he said. He specifies.
“In summary, there are many benefits to herding – learning and copying the beliefs and behaviors of others – and it is a very common human instinct that draws 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 take the time to think about why you believe what you do or act the way you do you do (and why others can be counterproductive). in doing so), you expose yourself to the risk of following the herd to the edge of a cliff.
A perfect example would be investors who purchased bitcoin shortly before the cryptocurrency hit an all-time high in late 2021.
While the digital currency was worth over $60,000 CoinMarketCap at the time, it declined a bit afterward, falling below $17,000 in 2022.
Even though the world’s most important digital currency has recovered significantly since then, investors who bought bitcoin shortly before that peak have still not recouped their losses.
In light of such stories, following the herd is not always the best option.
Lehman spoke about it, offering a deeper insight.
“Investing today 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’s easy to assume that there is wisdom in the actions of the mob and that’s not always the case.”
Disclosure: I own Bitcoin, Bitcoin Cash, Litecoin, Ether, EOS and SOL.