Saturday, June 16, 2012
Understanding Panics and Stampedes
Since I am suffering from the effects of the current panic in TASE (generated by Europe's three year old on-out panic - it may be worthy to spend an hoour of this Saturday morning meditating on the phenomenon. How can it be that if everyone does what seems best to him in the market, the end result will be disaster for all. It is rational to buy when prices are increasing by the day, because profits can indeed be made. But the more people make that individually rational choice, the more irrational the whole thing becomes. It is like a stampede to an exit door in a fire. Each person's individual best choice is to get out as quickly as possible. But if you allow that psychological reality to play out, people will be trampled to death at the door. Moreover, the corpses will block everyone else from escaping. Panic is the worst behaviour for tghe collective and for the individual, yet it seems inevitable. Pic.: The Duisburg Stampede. 50 dead. Addendum: Why a system goes from a stable mood to the disorderly panic mood? Say I am a front raw hoplite in a battle. I look to my right and left and see that everybody is advancing steadily towards the enemy line. My best chance of survival is to go with the line and not to run away. When I see disorder to my side and people running frantically from the enemy, I dont know exactly what is happening but the signal is clear and from that point everybody may be running away and the last one to run away will be captured and killed. From the instant of collapse the optimal behaviour is panic. As a corollarium, the leader must be always alert to signs of panic and he must kill it before it has time to go viral. The same in the bourse: when there is a selling panic, it can be stopped and reversed by a large buyer.