A Man and his son were visiting the market with their donkey. As they were walking along by his side a villager passed them and said, “You fools, what is a Donkey for but to ride upon?” So, the man put his son on the donkey, and they went on their way. But soon they passed a group of men, one of whom said, “See that lazy youngster, he lets his father walk while he rides.” So the man ordered his son to get off and got on himself. But they hadn’t gone far when they passed two women, one of whom said to the other, “Shame on that lazy lout to let his poor little son trudge along.” Well, the man didn’t know what to do, but at last, he took his son up before him on the donkey. By this time they had come to the town, and the passers-by began to jeer and point at them. The man stopped and asked what they were scoffing at. The men said, “Aren’t you ashamed of yourself for overloading that poor donkey of yours, you and your hulking son?”
The man and his son got off and tried to think about what to do.
They thought and they thought until at last they cut down a pole, tied the donkey’s feet to it, and raised the pole and the donkey to their shoulders. They went along amid the laughter of all who met them until they came to a bridge, when the donkey, getting one of his feet loose, kicked out and caused the boy to drop him at the end of the pole. In the struggle, the donkey fell over the bridge, and his forefeet being tied together, he was drowned.
The story may be old but the message is still relevant in present times. This is an example of how humans feel obliged to remain socially compliant even in situations that only require them to practice common sense. We force ourselves to adhere to the set norms and advice from our surroundings even though sometimes they are harmful or reckless. Just the way it happened in the case of the man and his son, who in the end lost the donkey.
In his conformity experiments (also known as the Asch paradigm) in the 1950s Solomon Asch, a Polish-American psychologist found that people were willing to ignore reality and giving incorrect answers to conform to the rest of the group. A clear sign of social proof.
The term ‘social proof’ coined by Robert Cialdini in his 1984 book Influence is explained as a psychological and social phenomenon wherein people copy the actions of others in an attempt to undertake behaviour in a given situation.
“Social proof, sometimes roughly termed the herd instinct, dictates that individuals feel they are behaving correctly when they act the same as other people,” explains the writer of the book The Art Of Thinking Clearly, Rolf Dobelli.
Now, let’s apply some of these understandings to investment scenarios. The stock market is one of the best places where this phenomenon can be observed on a large scale. Mediums like business channels, newspapers, mobile applications, social chat groups encourage people to behave in a particular manner while buying or selling stocks. These decisions are often influenced by the decisions of people in the surrounding without taking into account the fundamentals of the scrips and their own risk profiles. The recent frenzy around cryptocurrencies like Bitcoin, Dogecoin, and others explains how people went on a buying and selling spree without any understanding of the usage of the currency, legality, and its future. This explains why Dobelli says: “Social proof is the evil behind bubbles and stock market panic.”
There is also a kind of fear among individuals that when most people agree, a dissenting voice must be a mistake. We often see charts presenting data on how more and more investors participate when markets are near their peak and exit when markets have already corrected.
So, how can one escape the social proof? The answer lies in ‘three-step learning’ derived from the folklore narrated in the beginning.
Listen to everyone, make a choice, and own it. Just like what Charlie Munger, an ace investor says: “what they do is sit, read and think throughout the day”. That’s what a smart investor needs to do. Not to be the man in the folklore who had an error in judgment by listening to everyone rather than making a rational choice. But be a good investor who first collects all the relevant information, verifies the data, and derives his conclusion (considering his risk profile and investment horizon) instead of being influenced by each piece of information that comes his way.
In the end, it’s important to note what Shane Parrish, Founder of Farnam Street says: “Judgement is the art of knowing what to ignore”.(Reference : Book The Art Of Thinking Clearly by Rolf Dobelli)
