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The details vary, but the underlying dynamics are usually similar.The themes that provide warning signals in every boom/bust are the general ones: that excessive optimism is a dangerous thing; that risk aversion is an essential ingredient for the market to be safe; and that overly generous capital markets ultimately lead to unwise financing, and thus to danger for participants. In short, the details are unimportant and can be irrelevant. But the themes are essential, and they absolutely do tend to recur. Understanding that tendency—and being able to spot the recurrences—is one of the most important elements in dealing with cycles. (page 36)

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Cycles have more potential to wreak havoc the further they progress from the midpoint—i.e., the greater the aberrations or excesses. If the swing toward one extreme goes further, the swing back is likely to be more violent, and more damage is likely to be done, as actions encouraged by the cycle’s operation at an extreme prove unsuitable for life elsewhere in the cycle.

In other words, the potential for havoc increases as the movement away from the midpoint increases: as economies and companies do “too well” and stock prices go “too high.” Advances are followed by mere corrections, and bull markets by bear markets. But booms and bubbles are followed by much more harmful busts, crashes and panics. (pages 28–29)

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Most people think of cycles as series of events that follow each other in a usual sequence: upswings are followed by downswings, and then eventually by new upswings. But to have a full understanding of cycles, that’s not enough. The events in the life of a cycle shouldn’t be viewed merely as each being followed by the next, but—much more importantly—as each causing the next. (page 30)

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The things I call cycles do not stem completely—or sometimes at all—from the operation of mechanical, scientific or physical processes. They would be much more dependable and predictable if they did—but much less potentially profitable. (This is because the greatest profits come from seeing things better than others do, and if cycles were totally dependable and predictable, there would be no such thing as superiority in seeing them.) Sometimes there is an underlying principle (and sometimes not), but much variation is attributable to the role of humans in creating cycles. The involvement of humans in this process enables their emotion- and psychology-induced tendencies to influence cyclical phenomena. Chance or randomness also plays a big part in some cycles, and human behavior contributes to their existence, too. Humans are a big part of the reason these cycles exist, but also—along with randomness—for their inconsistency and thus their undependability.

The effort to explain life through the recognition of patterns—and thus to come up with winning formulas—is complicated, in large part, because we live in a world that is beset by randomness and in which people don’t behave the same from one instance to the next, even when they intend to. The realization that past events were largely affected by these things—and thus that **re events aren’t fully predictable—is unpleasant, as it makes life less subject to anticipation, rule-making and rendering safe. Thus people search for explanations that would make events understandable . . . often to an extent beyond that which is appropriate. This is as true in investing as it is in other aspects of life. (pages 41–42)

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Why is the pendulum of psychology important? In essence, the too-strong upward and downward swings of the cycles I’m covering in this book largely result from—and represent—psychological excesses in action.

In business, financial and market cycles, most excesses on the upside—and the inevitable reactions to the downside, which also tend to overshoot—are the result of exaggerated swings of the pendulum of psychology. Thus understanding and being alert to excessive swings is an entry-level requirement for avoiding harm from cyclical extremes, and hopefully for profiting from them.

The norms in terms of growth and appreciation are in some sense “right” and “healthy.” And if the participants built their behavior around those norms—instead of occasionally building up hopes for more and thus setting the stage for eventual moves toward less—the world would be a steadier, less-tempestuous, and less-error-prone place. But that’s not the nature of things. (pages 85–86)