Module XIX·Article II·~3 min read
Herding and FOMO
Investor Psychology and Behavioral Finance
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Herding and FOMO
Herding and FOMO: Herd behavior and fear of missing out
Herding (herd behavior) is the tendency to follow the actions of others, especially under conditions of uncertainty. FOMO (Fear of Missing Out) is the fear of missing out on a lucrative opportunity, compelling people to make irrational decisions.
Why do people follow the crowd?
| Reason | Description |
|---|---|
| Information cascade | “Everyone knows something I don’t know” |
| Social proof | Others’ behavior = signal of correctness |
| Career risk | “It’s better to be wrong collectively than right alone” |
| Evolutionary psychology | Safety in the group |
FOMO: Anatomy
- Social comparison — “Everyone is making money except me”
- Regret aversion — “I don’t want to regret not buying later”
- Selective attention — we only see others’ successes
- Recency bias — the latest trend = the future trend
Historical bubbles
| Bubble | Year | Growth | Decline | Characteristic features |
|---|---|---|---|---|
| Tulipmania | 1637 | 12x in 3 years | -99% | “This bulb = annual income” |
| South Sea | 1720 | 8x in 6 months | -84% | Even Newton lost his fortune |
| Dot-com | 1999-2000 | NASDAQ 5x in 5 years | -78% | “Profit isn’t important, clicks matter” |
| US Housing | 2006-2007 | Prices +100% | -30% | “Homes never go down in price” |
| Crypto | 2017, 2021 | BTC +1000% | -75% | “This time is different” |
| Meme Stocks | 2021 | GME +1600% | -80% | “Diamond hands” |
Signs of a bubble/FOMO environment
- Taxi driver test — when a taxi driver gives stock advice
- “New era” thinking — old rules no longer apply
- Leverage increase — margin debt at highs
- IPO frenzy — any IPO +100% on first day
- SPAC boom — blank check companies everywhere
- Celebrity endorsements — celebrities promote assets
Contrarian Thinking
Warren Buffett: “Be fearful when others are greedy, be greedy when others are fearful.”
| Crowd Sentiment | Contrarian Action | Historical Return |
|---|---|---|
| Extreme Fear (VIX > 40) | Buy equities | +25% avg 12-month |
| Extreme Greed | Reduce risk, hold cash | +5% avg 12-month |
| Normal | Stay invested | +10% avg 12-month |
Protection from Herding/FOMO
| Mechanism | Description |
|---|---|
| Investment process | Follow the process, not headlines |
| Valuation discipline | Don’t buy above fair value |
| Devil’s advocate | There’s always someone arguing against |
| Historical context | This has happened before |
| Pre-mortem | What could go wrong? |
CIO Test
If your analysis is correct and the market drops without any news—the most difficult, but correct action: buy more.
If everyone around is boasting profits and you’re not participating—that is not a reason to enter.
CIO Recommendations
- Process over outcome — a good process is more important than short-term results
- Limit media consumption — financial news = noise
- Seek disconfirming evidence — look for counterarguments
- Long-term focus — think in years, not weeks
- Remember survivors — you only hear success stories
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