In this chapter, Dreman examines the irrationality of some investor behaviour, and how that irrationality often culminates in bubbles that end up costing investors dearly. Bubbles are not just formed by sub-average investors; instead, many of the sharpest minds become so enamoured with an idea that they will behave completely irrationally.
There are four elements to a bubble according to Dreman. First, an image of instant wealth is presented. This image drives some to dream rather than think, and therefore a crowd forms around the idea.
Second, a social reality is created. Opinions become "facts". Experiments have shown that in uncertain circumstances, we rely on the opinions of others in forming our own opinions. Often, we do it without even realizing that the opinions of others are altering our own. Dreman argues that the appropriate price of a stock, or a piece of real-estate, or a tulip bulb are excellent examples of things of which we are uncertain, causing us to rely on the opinion of experts.
Third, the opinion suddenly changes. Perceptions can change quickly in the market. Opinions that harden over years can turn out of favour in just a few short weeks or months. Overconfidence is then replaced with anxiety. Prices crash.
Fourth, the pattern repeats itself. Circumstances appear different, but they are not. Things seem "different this time", but that is part of the illusion. As an example, Dreman shows how the IPO market has fluctuated several times, becoming hot at several points (resulting in circumstances where, say, Netscape can trade at 375 times its earnings shortly after its IPO), resulting in big losses for investors at the top. Yet the pattern persists.