Human behavior is inherently prone to herding, and the significant influence this behavior may have on the world’s asset markets is exemplified by the frequent dramatic fluctuations witnessed by cryptocurrencies.
These digital assets have bullish times, which can involve exuberant optimism and gains that are mind-boggling, and bearish times, which are marked by frantic selling and large losses.
Although there are undoubtedly contrarian investors in the cryptocurrency field, a large number of market players engage in herding, which is essentially the practice of following the behavior of the larger group rather than performing independent research.
Herding behavior is said to be present in all members of the animal world, including humans, according to scientists.
The phenomenon known as FOMO, or “fear of missing out,” is a prominent illustration of how this influences our financial decision-making. Market analysts often cite this as a reason for the sudden and dramatic increases in cryptocurrency values.
Why is this habit so deeply rooted? On this specific topic, a number of scholars and other professionals offered their opinions in an effort to pinpoint the precise causes of our strong inclination to follow the crowd.
Consumer psychologist Dr. Simon Moore provided a rationale for why individuals exhibit such a strong inclination to follow groups.
Because we are social beings, humans are naturally inclined to be socially connected. Moore stressed in email responses that he is the CEO and chief psychologist of the behavioral strategy agency IB, located in London.
Group involvement guarantees that we enhance our capacity for resources (from other members of the group) as well as help and support from them (both psychologically and physically), he said. Groups provide us the impression of protection and security.
According to Moore, individuals typically give weight to the judgments and behaviors of the majority because they mistakenly believe that if a large number of people act or think a certain way, it is more likely to be true.
A similar opinion was expressed by Richard Lehman, an adjunct professor of behavioral finance at UC Berkeley Extension, who claimed that herding provides human comforts and is unquestionably a major factor in our social lives today.
But in investing and finance, it can have unfavorable consequences,” the expert—who founded BehavioralFinance.com and acts as its primary educator—emphasized in an email.
He went on to say that it tends to make people follow other people blindly and fuel FOMO, or the fear of missing out, neither of which are thought to be reasonable reasons to make particular investments.
Extremely, herding tendency is blamed for past stock market bubbles and crashes, tulip crashes, and other similar events.
A Practical Detour
David Nussbaum provided a useful justification for why people frequently follow the herd. He is currently an adjunct associate professor of behavioral science at the University of Chicago Booth School of Business.
According to his email remarks, “Humans are social animals, so it makes sense that they frequently turn to others to learn about the world.”
Although there are undoubtedly significant exceptions, Nussbaum, who teaches a course on Power and Influence at the business school, pointed out that it can often be a really helpful tactic – if everyone else is doing it, there’s generally a good reason and it’s not likely to be dangerous.
He underlined that we may learn a lot about appropriate behavior by observing what other people say and accomplish.
The scholar said, providing more context on the matter, that it can also matter a great deal whose behavior we’re focusing on and what it says about ourselves.
It makes sense, for instance, to emulate the actions of those who resemble us or whose identities we aspire to — in the case of cryptocurrency, you would conclude that it indicates that you’re daring and inventive — but it makes far less sense to emulate the actions of those who we do not identify with (for instance, it would be odd for an adult to attend a child’s birthday party and emulate the conduct of the children instead of the parents), he clarified.
Nussbaum found that “herding”—that is, picking up on and imitating the beliefs and behaviors of others—has many advantages and is a strongly ingrained human inclination that stems from a lengthy evolutionary past.
Buyer Beware
Observing that “if you blindly follow the behavior of others and rarely pause to reflect on why you believe what you believe 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,” the expert pointed out that following a larger group can be counterproductive.
An exemplary case in point would be investors that purchased bitcoin just prior to its peak value in late 2021. The value of the virtual currency dropped significantly after that, hitting less than $17,000 in 2022, despite being worth more than $60,000 at the time according to CoinMarketCap.
Even while the most well-known digital currency in the world has made huge gains since then, investors who bought bitcoin just before its peak are still out of pocket. These kinds of tales make it clear that it’s not always a good idea to follow the herd.
Lehman addressed this and provided more details. He pointed out that investing in the modern day can be challenging and involves knowledge, experience, and data that many people lack. Thus, Lehman went on, it makes sense to ask for advice from others. However, it is not always the case to assume that the decisions made by the masses are wise.
