What role does human psychology (herd mentality, irrational exuberance) play in a crisis?

Okay, this is a very interesting question, and it's particularly relevant to our daily lives. Let me share my thoughts, trying to explain it in simple terms.

The "Inner Demons" in a Crisis: Why Do We Keep Repeating Mistakes?

Imagine you're at a lively party. At first, everyone is a bit reserved, but as the music gets louder and the atmosphere heats up, more and more people start dancing, and you can't help but sway along. Suddenly, someone shouts, "Fire!" Even if you don't see smoke, but you notice everyone around you rushing out, what's your first reaction? Most likely, you'd run with them, right?

"We" in a financial crisis are actually quite similar to the people at that party. And what drives our behavior are those two "inner demons": irrational exuberance and the herd effect.

Phase One: The Party Frenzy — "Irrational Exuberance"

Before a crisis erupts, there's often a period that seems endlessly wonderful. This is "irrational exuberance."

• What is it? Simply put, it's "collective euphoria." Everyone is overly optimistic, believing that good times will last forever and that making money is too easy. For example, everyone believes "housing prices will always rise," or "buying this stock will lead to financial freedom."
• How does it work? This optimism is contagious. When you see your neighbor, Old Wang, making a fortune from stocks/real estate, it's hard not to be tempted. The media also reports "rags-to-riches" stories daily. As a result, more and more people pour their money in, and asset prices (like stock prices, housing prices) are pushed higher and higher, far exceeding their intrinsic value. At this point, risks are thrown to the wind, and people firmly believe, "This time it's different."

You can imagine it as a balloon being inflated bigger and bigger. Every participant believes the balloon can get a little larger, and they certainly won't be the last unlucky one to hold it.

Phase Two: The Panic Stampede — "Herd Effect"

When that huge bubble is pricked by a tiny needle (like bad news, or a company going bankrupt), the rules of the game change.

• What is it? It's exactly what we talked about at the beginning: "running with the crowd." It's human instinct, in uncertain and dangerous environments, to imitate the behavior of the majority because it feels "safer."
• How does it work? When asset prices start to fall, panic spreads. When you see others selling, you fear that if you don't sell now, you'll lose everything. So you follow suit and sell. One person sells, then two, and eventually, thousands of people are frantically selling. This collective selling behavior leads to a cliff-like drop in asset prices, with the depth and speed of the decline far exceeding the deterioration of fundamentals (like a company's actual operating conditions).

This is like a stampede in a "burning theater." The exit is clearly there, but because everyone crowds to rush out, it causes greater chaos and harm. In financial markets, this stampede is a crash.

To summarize this cycle:

1. Irrational Exuberance (Blowing the Bubble): Due to excessive optimism, everyone rushes to buy, pushing prices to exorbitant levels.
2. Bubble Burst (The Needle Arrives): A negative event occurs, and confidence begins to waver.
3. Herd Effect (Stampede for Survival): Due to fear, everyone rushes to sell, leading to a price collapse.

Therefore, human psychology plays the role of an "amplifier" in a crisis. When prices rise, it amplifies greed, creating huge bubbles; when prices fall, it amplifies fear, causing devastating crashes.

Understanding this, perhaps next time when we see everyone around us going crazy over something, whether it's an investment or anything else, it can give us a bit more calm and independent thought. After all, in a herd, following along doesn't always lead to green pastures; it might lead off a cliff.