Second, quite frequently the crowd is mistaken because they are not acting on the basis of any superior information but are reacting, themselves, to the principle of social proof. Over the past decade or so, the social proof has generally served investors well. The idea that investing in stocks is the most effective way to build wealth over time has caught on and snowballed throughout society. It is also evidence of the social proof at work. On the individual level, investors need only look back at their annual returns from their stock holdings over the later half of the 1990s to see how much the social proof has positively affected their financial lives.
Problems arise, however, when uncertainty creeps into the picture.
As Cialdini points out in the previously cited passage, heightened uncertainty has a way of magnifying the power of the social proof. Prices fall, people take a look at their paper losses, wince, and then join in on the selling. This progression of events might seem like so much theorizing and psycho-babble if it weren't for the fact that herding behavior is actually wired into the financial system through the major institutions in the market. This is an important point. Second, bankers and investors are often measured and rewarded by relative performance, so it literally does not pay for a risk-averse player to stray too far from the pack.