Why do we tend to follow the herd?

Herding is ingrained in human behavior, and the profound impact it can have on global asset markets is quite evident in the sharp fluctuations that cryptocurrencies frequently experience.

These digital assets go through bullish periods that can include unbridled optimism and amazing 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 participate in the herd, meaning they follow the actions of the broader group rather than conducting their own analysis.

Scientists have described herding behavior as universal in the animal kingdom, without excluding humans.

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 spikes in cryptocurrency prices.

Why is this behavior so ingrained? Many academics and other experts have addressed this very question, seeking to pinpoint the exact reasons why we are so tempted to follow the herd.

Groups offer “Safety and Security”

Dr Simon Moore, chartered consumer psychologist, highlighted the practical reason why people show such a strong inclination towards the following groups.

“Humans are social creatures – and as such we tend to be sociable,” Moore, who is chief psychologist and CEO of London-based behavioral strategy agency IB, confirmed via email.

“Groups provide us with a perception of safety and security – and group membership also ensures that we increase our potential to obtain resources (from others in the group) as well as help and support from them (physical and psychological),” he noted.

“So humans generally give weight to the actions and decisions of the majority (inaccurately thinking that if a lot of people act or think this way they are more likely to be right),” Moore said.

Richard Lehman, an assistant professor of behavioral finance at the University of California, Berkeley, offered a similar view, saying that “pastoralism provides human comfort and is clearly a major driver in our social lives today.”

“In finance and investing, it can have undesirable effects,” the expert, who is also the founder and chief educator of BehavioralFinance.com, stressed via email.

“It tends to make people blindly follow others and contributes to FOMO – fear of missing out – neither of which is a rational reason to invest in certain things,” he added.

“At the extreme, herding behavior is cited as a contributing factor to historical bubbles, stock crashes, tulips, and other such items.”

Useful shortcut

David Nussbaum, currently an adjunct associate professor of behavioral sciences at the University of Chicago Booth School of Business, offered 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 email comments.

“It can often be a very useful strategy — if everyone is doing it, there's probably a good reason, and it's unlikely to be dangerous — although there are certainly major exceptions,” noted Nussbaum, who teaches a course on Power and influence in the business school.

“By paying attention to what others say and do, we can learn a lot about the right ways to behave,” he stressed.

“It may also be very important what the behavior of the person we pay attention to and what he says about us,” the academic said, providing more nuance on this topic.

“For example, it might make sense to imitate the behavior of people who look like us, or have an identity that we aspire to — for crypto, I imagine what you think it says is that you're bold and innovative — but there's more to it than it makes sense to imitate people we don't look like,” he explained. With them (it would be strange if an adult came to a children's birthday party and imitated the behavior of the children instead of the parents).

“In short, there are many benefits to ‘estrangement’ – learning from and imitating the beliefs and behaviors of others – a very common human instinct based on a long evolutionary history,” Nussbaum concluded.

Buyer awareness

The expert pointed out that following a larger group can be counterproductive, noting that “if you blindly follow the behavior of others and rarely stop to think about why you believe what you do or act the way you do (and why others might be like that”) if you do ) You expose yourself to the risk of following the herd to the edge of the abyss.

A good example of this is investors who bought Bitcoin shortly before the cryptocurrency reached an all-time high in late 2021.

While the cryptocurrency was valued at over $60,000 on CoinMarketCap at the time, it declined slightly after that, falling below $17,000 in 2022.

While the world's most prominent digital currency has recovered significantly since then, investors who bought Bitcoin shortly before this peak have yet to recoup their losses.

In light of stories like these, following the herd isn't always the best option.

Lyman spoke about this, offering more insight.

He pointed out that “investing nowadays can be complex and requires knowledge, experience and data that many people do not possess.”

“So asking others for advice is a rational thing to do,” Lehman continued.

“But it is easy to assume that there is wisdom in the actions of the masses, and that is not always the case.”

Disclosure: I own some Bitcoin, Bitcoin Cash, Litecoin, Ether, EOS, and SOL.

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