The herding effect does not spare anyone

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Try to imagine yourself inside an international airport of any large city where, just when you get out, you see that nobody is expecting you.

You are tired and disoriented by the signs in a language that, even if you know it, is not your first; by the crowd, the lights and the jet lag: which criteria do you choose to decide the direction to follow?

Probably, you will let your instinct guide you and you will go towards the direction that the largest group of people is following. In other words, you will be unawarely victim of the herding effect. This effect is tightly connected to the principle of social proof, theorized by the leading expert in persuasion, psychologist Robert Cialdini: doing something that is recognized as socially acceptable just because the mass, the collective consider it so.

Its validity was further confirmed by a recent study conducted by the Istituto per le Applicazioni del Calcolo of the Sapienza University in Rome: two groups of forty people were asked to exit a room to go to a destination that nobody knew, except one person in the group and five people in the other group. After some initial moments of hesitation, during which some individuals went straight to the Departments they knew better, all participants followed the “moles”, or the people that seemed to know exactly where to go, rapidly arriving at the final destination.

This experiment made possible the demonstration that in situations of doubt and uncertainty human beings tend to act like a herd (from this the denomination “herding effect of the gregarious instinct”), or as a big group of “agents” that follow elementary rules and whose behavior was influenced by that of the closest agents. In other words, when someone is not certain of what the best thing to do is, they are led to act in the same way of whoever is closest.

The stronger the individual belief in free choice is, no matter how much the behavior is conformed to the norm, the more probable the herding effect is. “Unity makes strength“, in summary, as long as someone believes that the choice of conforming to norm is self-determined in absolute freedom.

Try to imagine yourself inside an international airport of any large city where, just when you get out, you see that nobody is expecting you.

Daily examples

The mechanism exists in the animal world, too, it’s sufficient to see how they act when they are faced with an uncertain situation such as crossing a river: they group themselves and they cross it together and in this way they have the highest chance to survive. The same thing applies to fish, when they group themselves in a large ball as to appear as a single giant fish that is able to scare predators. Anytime there is a perceived risk, moving in a group guarantees a higher chance of survival. This mechanism exists also in the human psyche: if we see a group of people looking up, we feel a force that leads us to do the same thing.

Other examples? We fall in the same trap every time we book a restaurant or hotel or we buy something online. The tendency is to buy from sellers that have a certain number of sales on their back and several positive feedbacks: in summary, everything we want is to be reassured. This is the reason the company websites show their customers’ feedbacks on their landing page. This technique plays on two factors: it leads to the purchase and it simultaneously leads the potential buyer that is reading the feedback to feel like the only person that hasn’t tried the new product or service yet, causing in them a sort of sense of inadequacy. In summary, the sense of belonging to a group, a community is exploited and the gap can be filled with a simple (and impulsive) click.

In the finance world, the herding effect happens when investors decide to trust the behavior of the mass to confirm their choices with regard to investments. A phenomenon that occurs is the speculative bubble: particular phases in the market in which the price of goods/stocks increases unreasonably, when there is a sudden and powerful demand.

Consequently, the “herd of investors” is led to buy more to resell the stock at a higher price and make a gain, and then speculate on it. At the same time, when the price of stocks begins to decrease, becuase the potential of the company/stocks in which they have invested does not appear, the buying excess stops, producing disastrous effects for the whole “herd of investors” which speculated.

Advantages of the herding effect

Does acting like sheep bring advantages? Absolutely. With regards to the social aspects of gregarious instinct, when it is correctly “exploited”, it allows a better management of a great number of individuals in situations of emergency and great flux (it is sufficient to insert some hidden leaders in large groups, that know exactly that to do for everyone to follow them). Instead, regarding the personal psychological side, conforming to the norm is never wrong, as someone will think they were intelligent to conform (autonomously, of course) if things went well. In case things turned bad, they will console themselves thinking they were not the only one to have made mistakes.

Laura Mondino

Sources

Banerjee, A. (1992). A simple model of herd behavior, Quarterly Journal of Economics, 107, 797-817.

Berger, S., Feldhaus, C., & Ockenfels, A. (2018). A shared identity promotes herding in an information cascade game. Journal of the Economic Science Association, 4(1), 63-72.

Bikhchandi, S., Hirschleifer, D., & Welch, I. (1992). A theory of fads, fashion, custom and cultural change as informational cascades. Journal of Political Economy, 100, 992-1026.

Economou, F., Hassapis, C., & Philippas, N. (2018). Investors’ fear and herding in the stock market. Applied Economics, 50(34-35), 3654-3663.

Lin, M. C. (2018). The impact of aggregate uncertainty on herding in analysts’ stock recommendations. International Review of Financial Analysis, 57, 90-105

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