Herd behavior and FOMO in investing: cascades, manias and panics

Herd behavior is following what other investors do instead of acting on your own information and analysis. FOMO, the fear of missing out, is the emotion that often powers it: the anxiety of watching other people make money on something you do not own. Together they push investors into manias near their peaks and out of markets near their lows.

Herding is not pure foolishness. When you know little and others seem to know more, copying them can be a reasonable shortcut, and economists have shown how perfectly sensible people can end up in a herd that is wrong. That is what makes it hard to resist. This article explains why herds form, what the research on real investors shows, how the 2021 GameStop episode and the April 2025 sell-off played out in the data, and what helps.

Why herds form

Social proof

People take cues from others, especially under uncertainty. In Solomon Asch's conformity experiments of the 1950s, participants judged which of three lines matched a reference line, an easy task, after hearing several confederates give the same wrong answer. Participants went along with the wrong majority on about a third of those trials, and most conformed at least once. Markets are far more uncertain than line lengths, so the pull of the crowd is stronger.

Informational cascades

In 1992 two papers, one by Sushil Bikhchandani, David Hirshleifer and Ivo Welch and one by Abhijit Banerjee, showed how rational people can form a herd. The idea can be told with two restaurants. Each diner gets a private, imperfect hint about which restaurant is better and can also see where earlier diners went. If the first two choose restaurant A, the third diner may reasonably ignore a private hint favoring B, because two choices outweigh one hint. From then on every diner reasons the same way, and everyone goes to A, even if most of them privately had hints favoring B.

Three features of cascades matter for investors. They can start from very little information (the first two choices). Once started, the crowd's behavior stops adding information, because later people are copying, not judging. And cascades are fragile: a small piece of public news can reverse them suddenly, because nobody's conviction was deep. That pattern, long runs followed by abrupt reversals, is typical of manias.

Reputational herding

Professionals herd too, for career reasons. David Scharfstein and Jeremy Stein showed in 1990 that a manager who worries about how others judge his ability has an incentive to copy other managers: being wrong along with everyone else does less damage to a reputation than being wrong alone. John Maynard Keynes made a similar point in 1936, comparing professional investing to a newspaper beauty contest in which entrants win by picking the faces other entrants will pick, not the faces they find prettiest.

Attention

Individual investors face thousands of stocks to buy and only the few they own to sell. Brad Barber and Terrance Odean showed in 2008 that this asymmetry makes individuals heavy net buyers of stocks that catch attention, those in the news, with unusually high volume or with extreme one-day moves. Attention is shared, so many people buy the same stocks on the same days. A 2022 study by Barber, Xing Huang, Odean and Christopher Schwarz found that Robinhood users, guided by app features that highlighted top movers, bought in concentrated bursts, and that stocks with the most intense herding episodes went on to post negative abnormal returns.

FOMO and performance chasing

FOMO is the felt side of herding. It is strongest when gains are visible, recent and made by people similar to you: friends, coworkers, strangers posting account screenshots. Its investing signature is performance chasing, buying what has already risen.

Mutual fund flows show the pattern on a large scale. Erik Sirri and Peter Tufano found in 1998 that money pours into the funds with the best recent returns while poorly performing funds lose relatively little, so flows chase past winners. Because investors tend to arrive after strong runs and leave after weak ones, the return the average dollar earns can fall short of the fund's own reported return. Morningstar measures this gap each year in its "Mind the Gap" study; in recent editions it has been on the order of one percentage point a year across US funds.

Case study: GameStop, January 2021

At the end of 2020 GameStop, a struggling video-game retailer, was one of the most heavily shorted stocks in the US market. A growing community of retail investors on social media argued that the shorts were overextended. In January 2021 buying from that community, call option purchases and short sellers covering their positions fed on each other, a classic Short squeeze: how it works, warning signs and the GameStop case.

In split-adjusted terms the stock closed December 2020 at $4.71, traded as high as $120.75 in January 2021 and closed the month at $81.25, up about seventeenfold. On January 28 several brokers restricted purchases of the stock, and it closed February at $25.43. It spent much of 2021 between roughly $40 and $55 at month-end and closed 2023 at $17.53. The SEC's staff report on the episode, published in October 2021, describes the mechanics, including the role of short covering and the broker restrictions.

The episode illustrates both sides of herding. Early buyers who acted on their own analysis and sold into the frenzy made large gains. The crowd itself then became the main reason to buy: people bought because others were buying and prices were rising, which is the definition of a cascade. Many of those who arrived near the top lost most of their money. Whether the original thesis was right never decided the price; the flow of buyers did.

Panic: herding in reverse

Herds also run for the exits. When prices fall fast, selling looks like information, headlines amplify fear, and loss aversion (see Loss aversion: why losses hurt twice as much as gains please) makes each further decline harder to bear. The danger is not only selling low. It is being out of the market for the rebound, because the biggest up days tend to arrive in the middle of turbulence.

The spring of 2025 is a compact example. After closing at $612.93 on February 19, 2025, SPY slid through March and then fell 4.9% on April 3 and 5.9% on April 4 following the announcement of broad US tariffs. It closed at $496.48 on April 8, 19.0% below the February high. On April 9, after a pause on most of the new tariffs was announced, it rose 10.5% in a single day. The three worst days and the best day of the whole two-year period all fell between April 3 and April 10, a span of six trading sessions.

An investor who sold on April 4 or April 7 to stop the pain would have missed that day.

Over the 500 trading days from October 30, 2024 to October 29, 2026, $10,000 in SPY grew to about $13,265 on price alone. Removing the single best day, April 9, 2025, cuts the result to $12,004. Missing the best 10 days leaves $9,658, a loss.

Is going against the crowd the answer?

Not automatically. Crowds are often right, especially about trends: Momentum is one of the most persistent patterns in stock returns, and fighting a strong trend early has ruined many short sellers, including during the The dot-com bubble: the 1995–2002 boom and the 78% Nasdaq fall. A Contrarian who simply does the opposite of the herd is still letting the herd decide. The useful habit is independence: forming a view from evidence you can name, and being able to say what the crowd might know that you do not.

Signs that a decision is being driven by the herd rather than by analysis:

• You learned about the investment this week, from social media, a trending list or a friend's gains.
• Your main reason to buy is that it has gone up, or to sell is that it has gone down.
• You feel urgency: the chance will be gone tomorrow.
• You cannot describe what the company does or how it makes money, or what price would be too high.
• You would be embarrassed to explain the trade if it went wrong.

Defenses that work

A waiting period. A rule such as "no purchase of anything I first heard about in the past seven days" lets the excitement fade before money moves. Most genuine opportunities survive a week; most FOMO does not.

Position limits. Capping any single speculative position at a small share of the portfolio, decided in advance, limits the damage when the crowd turns. See Position sizing: how many shares to buy for a set risk.

A written reason that excludes other people. If the case for a trade cannot be stated without "everyone is buying it," it is not a case.

Pre-decided responses to crashes. Deciding before a sell-off what you will do in one, for example rebalance back to target weights, gives you something to do other than follow the herd out. See Rebalancing a portfolio: calendar vs threshold, drift and taxes.

Less exposure to the stream. Turning off price notifications, following fewer market accounts and checking quotes on a schedule reduce the number of FOMO triggers.

How Finabase helps

Finabase shows attention without telling you what to do with it. The trending page lists the 50 symbols drawing the most interest in the current session, plus the pre-market and after-hours movers, which is useful as a map of where the crowd is looking rather than as a buy list. The news feed and each symbol's News tab show what is behind a move before you react to it. Alerts let you set a price you would act at in advance, and the comparison tool shows how a hot stock's past year compares with a broad index.

Frequently asked questions

What is herd behavior in the stock market?

Herd behavior is investors copying what other investors are doing rather than relying on their own analysis. It can be rational when others seem better informed, but when many people copy each other their trades stop carrying new information, which can push prices far from fundamentals in both directions.

What does FOMO mean in investing?

FOMO, the fear of missing out, is the anxiety of seeing others profit from an investment you do not own. It typically leads to buying after a large rise, often at the point when the easiest gains have already been made.

Why do investors panic sell?

Fast declines combine loss aversion, alarming news and the sight of other people selling. Each of those makes selling feel safer. The cost is that rebounds often come quickly and close to the worst days, so panic sellers frequently miss them.

How do I avoid FOMO when investing?

Use rules that slow decisions down: a waiting period before buying anything new, a cap on speculative positions, a written reason for each purchase that does not depend on what others are doing, and fewer price notifications.

Summary

Herding is following the crowd, and FOMO is the feeling that drives it. Informational cascades show how sensible individuals can produce a herd built on little information, which is why manias run long and reverse abruptly. Real investor data show attention-driven buying and performance chasing, and episodes of concentrated retail herding have tended to be followed by weak returns. GameStop's January 2021 spike and the April 2025 sell-off show the two faces of the same behavior: buying because others are buying, and selling because others are selling, often just before the best day. Independence, not contrarianism, is the goal, and waiting periods, position limits and written reasons are the tools that make it practical.