The Market Pendulum: How to Profit from the Extremes
I recently reread "The Most Important Thing" by Howard Marks, and there's one idea that keeps hitting me: markets are pendulums, not thermometers.
A thermometer simply reflects the current temperature. A pendulum swings from one extreme to the other, and the real game is predicting when it will reach the maximum or minimum.
Most investors and entrepreneurs make the same mistake: they operate as if the market were a thermometer. They see something rising and think "this will keep rising". They see something falling and think "this will keep falling".
Marks says this is backwards.
The Pendulum Cycle: From Reason to Emotion
Everything starts at the center. The market is in equilibrium. Prices reflect reality. Investors think rationally.
But then something happens. An opportunity appears. Or a threat. And the pendulum begins to move.
What's fascinating is that the pendulum never stops at the center. Never. It always overshoots.
When there's optimism, emotion takes control. Investors see opportunities everywhere. FOMO replaces analysis. Prices rise beyond what reality justifies. This is euphoria.
Then, inevitably, something gives. And the pendulum swings to the other side. Now fear replaces optimism. Everything seems bad. Investors sell everything. Prices fall beyond what reality justifies. This is panic.
And then it returns to the center. Or almost to the center, before starting again.
Marks calls it "the pendulum's journey between extreme optimism and extreme pessimism".
Why This Matters for Your Business
You don't need to be an institutional investor to understand this. If you build an online business, you're operating within markets that behave exactly like this.
Take the SaaS market. A few years ago, everything was AI. Investors funded anything with "AI" in the pitch deck. The pendulum was at the extreme of optimism.
Then interest rates rose. Reality hit. Suddenly, nobody wanted to fund AI startups without a clear business model. The pendulum moved toward pessimism.
Now we're somewhere in between, but not quite at the center. And this is where Marks says the real value is: when the pendulum has overshot too far in one direction, but most people haven't noticed yet.
This means:
- **In extreme optimism**: Prices are inflated. Margins are compressed. Competition is fierce. It's a bad time to enter.
- **In extreme pessimism**: Prices are low. Opportunities are overlooked. There's less competition. It's a good time to enter.
Marks' Framework: How to Recognize the Extremes
Marks doesn't give you a magic formula (because it doesn't exist). But he does give you a framework:
1. Observe behavior, not just numbers
When the pendulum is at the extreme, you'll see extreme behavior:
- People invest without analyzing
- Quality standards drop
- Ridiculous risks are accepted
- Everyone talks about the same thing at dinner parties
In Spain, we saw this with delivery startups years ago. Everyone invested. Everyone talked about it. Profitability standards didn't matter. The pendulum was far from center.
2. Ask yourself: Is this true or is it a story?
Marks emphasizes the difference between facts and narratives.
A fact: "This SaaS has 1000 customers paying monthly". A narrative: "This SaaS will be the Slack of document management".
When the pendulum is at the extreme, narrative replaces fact. People invest in stories, not realities.
3. Look at where money is flowing
When the pendulum is at the extreme of optimism, money flows toward:
- The newest
- The most speculative
- The least profitable (but with the best story)
When it's at the extreme of pessimism, money disappears from these places.
You want to be where money is starting to flow again, not where it's at its peak.
A Real Example: The Emergency Plumbing Market
I built Find Emergency Plumber years ago. At that time, the emergency services market was at an extreme of pessimism. Investors didn't want to touch anything related to local marketplaces.
Why? Because the pendulum had been at the other extreme years before. Too many local marketplace startups, too much competition, too many failures. The sentiment was: "That doesn't work".
But the numbers said something else. There was real demand. Margins were healthy. The problem wasn't the market; it was that it was being attacked incorrectly.
I entered when pessimism was at its peak. Less competition. Better margins. Less pressure to grow at any cost.
That's the pendulum. It's not magic. It's just being where others don't want to be.
How to Apply This Today
Step 1: Identify where the pendulum is in your industry
Is money flowing? Is there too much competition? Are margins being compressed? Does everyone talk about the same thing?
If the answer is yes to these questions, the pendulum is at the extreme of optimism.
Step 2: Look for where the pendulum has overshot too far toward pessimism
The best businesses are built where sentiment is negative but reality is positive.
What industries are being ignored right now? Where does everyone say "that doesn't work" but the numbers say something else?
Step 3: Be patient
Marks emphasizes again and again: timing is almost impossible to predict with precision. What matters is being approximately right, not perfectly timed.
Enter when pessimism is high. Don't wait for the exact bottom. It doesn't exist.
The Most Important Lesson
Marks says something that most entrepreneurs ignore: "Success in investing doesn't come from being right all the time. It comes from being right when it matters".
You don't need to get every decision right. You need to get the big decisions right. And the big decisions happen when the pendulum is at the extremes.
When sentiment is extreme, most people are blind. They see what everyone sees. They think what everyone thinks.
You want to be different. You want to see what others don't see. And that happens when the pendulum is far from center.
Summary: Your Next Move
Don't try to predict the future. Try to recognize where the pendulum is now.
Is it at the extreme of optimism? Be cautious. Wait.
Is it at the extreme of pessimism? Look for opportunities. Most money is made here.
Is it near the center? It's probably a bad time to enter something big. The pendulum will move soon.
This isn't complicated. It's just the opposite of what most people do. And that's exactly why it works.
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Where do you see the pendulum in your industry right now? Tell me what market you're operating in and where you think the pendulum is. Sometimes an outside perspective helps you see what's happening.