The Danger of Social Proof Effect In Investing (and in your life) - Must Read

One of the reason why technical analysis works is because we can use historical data to calculate a probability of what will happen in the next event.

Of course it will not be 100% accurate, however, based statistically data, it can gives us some indication of what is the next move.

Why is that so?

This is because the buying and selling market in the market is done by a lot of human beings.

(Do note that there is also algorithm or high frequency trading done by bots as well).

Human tends to be impacted by what others do.

When we see a share price shot up high in a short period of time due to a lot of buy volume, we tend to be interested and want to jump in as well.

Somehow we feel that we need to participate so that we will not lose out.

If so many people are buying, we want to buy as well.

[Kiasu effect ?].

And when more and more people flock to buy the same hyped-out share, the share price rises exponentially.

This is what we called as social proof effect.

However, we need to be careful of social proof effect.

In fact, we need to be VERY careful.

W. Somerset Maugham once said:

If forty million people say a foolish thing it does not become a wise one.

Social proof effect is used everywhere, especially in business.

I'm sure you will tend to buy a product if it has many good 5 stars review, vs a 1 star review.

Many online marketplace is using this strategy (sometimes against us?) to influence us to buy more.

Watch this hilarious social experiment video and you will understand that social proof effect is indeed very powerful, sometimes you will not even question it.

And it can become even more powerful if it is influenced by your friends and families isn't it?

This is why it is said that when we take the contrarian approach in investing, we can become more successful.

Which means that we need to learn not to be influenced by the crowd and need to have independent thinking.

Learn to do your own calculation and be objective in your decision making.

Do not listen to rumors and hearsay, especially those in the major news.

While we may still listen for advice, we need to learn to differentiate facts with social proof effect.

Sometimes culture and old practice will also affects us.

Matthew 7:13-14 (New International Version)

The Narrow and Wide Gates
13 “Enter through the narrow gate. For wide is the gate and broad is the road that leads to destruction, and many enter through it. 14 But small is the gate and narrow the road that leads to life, and only a few find it.

This is also why Warren Buffet can become so successful in his investing journey, and all of us can learn something from it.

He does not follow the crowd and thus is not impacted by the social proof effect.

Warren Buffet: “Be fearful when others are greedy, and be greedy when others are fearful.”

What do you think of social proof effect in your life?

Do you agree?

Do you have any life experiences to share?

Share it in the comment below.

Happy Investing! 😉