When the mob mentality gets you

Why do we we follow fashions? For the same reason that we buy stocks when the Sensex is at 21000 and sell stocks when it is at 5000.

To elaborate, one would expect that when the stock market is inordinately high, investors will go easy on buying stocks, preferring instead to sell their holdings. Similarly, when the stock market is really down, we would expect investors to buy stocks at bargain prices and not sell their holdings. Yet, what is observed in general is the exact opposite.

When the market is high, everybody wants to buy and when the market is low, everybody wants to sell. And then, at the height of the market, someone gets panicky and sells; then another one who knows him does the same; and then another and another till it is a veritable stampede and the entire market comes crashing down. Something similar happens with Ponzi schemes.

Clearly there is mob mentality involved here. We tend to do what everyone else is doing and everybody else is doing what everybody else is doing and so on, so that on the whole, everybody is following the actions of everybody else and the market goes up and up or down and down, resulting in huge volatility.

Following fashion, too, is nothing but herd mentality. Recent research in behavioural economics shows that decision-making is  often based on the actions of others. In this respect, we are little different from birds, sheep or lemmings.

The entire process begins with a few individuals aping the actions of a few others and then the process ripples out all the way. One might have noticed how after a lecture it takes a long time for the first question to be asked and then questions pour out in a torrent.

It takes a lot of self-confidence and resolve to go against the tide. What is worse, in most cases, so innate is the tendency to follow others that we do not even realise that we are being led in a wildebeest-like stampede.

Ever noticed how folks behave while waiting for their flight at the departures terminal when the flight is being announced? The announcer makes earnest entreaties that only women with babies in their arms or senior citizens may board the flight first. You find a lot of them (not from the above category) straining in their seats.

But before long, first one, and then a few more passengers simply can’t resist the temptation and get up from their seats and approach the departures turnstile and almost immediately you find passengers flocking towards the turnstile in a horde.

Herd mentality may be tested in controlled conditions. For example, if you privately arrange for a few individuals to cross a very busy street at a certain arbitrary point, it is very likely that a large crowd, which is not in verbal communication with the small informed group of individuals, will soon follow suit.

It has been found that in most situations, a few informed individuals can pull large crowds after them. According to researchers from the University of Leeds, a minority of 5% of informed individuals can lead the remaining 95% in a crowd in this manner.

The research has implications for understanding crowd behaviour, including fashions. These implications are useful in guiding the flow of crowds in disaster scenarios when verbal communications break down. That’s how politicians foment trouble in rallies. And why cellphones, iPods, and iPads catch on so fast.

In a related phenomenon, people prefer to fail conventionally  than succeed unconventionally. That’s why your fund manager is likely to recommend a well-known blue-chip stock for investment even if its performance is likely to be unspectacular, rather than
recommend a relatively unknown company engaged in genetic
research.

This is because even if his recommendation were to go wrong and the blue chip were to crash, it is difficult to fault the fund manager for recommending a safe stock, while had he recommended the other stock and had it bombed, God save him!