The Descent into Panic: How does FOMO keep us on the track?

In finance, bubbles — when asset prices soar only to crash — are driven by psychological forces, with FOMO (Fear of Missing Out) at the forefront. Studies by Barberis et al. (2018) show how investors tend to extrapolate recent trends, fuelling optimism that inflates prices. The fear of missing out on potential gains drives people to invest impulsively, often at inflated values, simply because others are doing the same.

This collective behaviour creates the conditions for a bubble, but when it bursts, panic sets in. As Shiller (2015) discusses in Irrational Exuberance, irrational exuberance leads investors to hold onto assets longer than they should, believing the market will recover. As the bubble pops, FOMO turns into FoLO (Fear of Losing Out) — the fear of loss makes people sell in a panic or hold on, hoping for a rebound.

Scheinkman & Xiong (2003) add that overconfidence also contributes to speculative bubbles, as investors believe they have control over their investments. The emotional rollercoaster of FOMO clouds rational decision-making, leading to impulsive actions. Understanding these psychological triggers, as outlined by Barberis, Shiller, and Scheinkman & Xiong, is crucial to making informed financial decisions and avoiding the chaos of emotional trading.