Understanding a Stock Market Crash

As stock markets hit new highs, is a sharp crash about to happen anytime soon?

While there is no threshold for stock market crashes, they are usually described as a sudden two-digit loss of prices over the course of a few days.

What is a stock market crash?

Stock market crashes occur when a stock index drops off more than 10 percent in day or two. They also would make investors sell at the lowest possible prices.

Market crashes strip off equity-investment values and are most risky to those relying on investment returns for retirement.

Even though the fall of equity prices can happen over a day or year, crashes are frequently followed by a recession or depression.      

Crashes can result to a bear market. This would reduce 20 percent or more in the market and it could last for about 18 months, which may trigger a recession.

Crash vs. Correction

The pace of the fall is what sets a stock market crash and a market correction apart. A crash takes place when markets suffer from a double-digit decline in a day or two. A correction on the other hand happens when prices shed at least 10 percent over days, weeks, or even a couple of months.

What triggers a stock market crash?

Major tragic events, economic crisis, or a long-term speculative bubble falling can cause a crash.

Panicked sellers are also usually accountable for setting off a crash. Typically, investors who believe the market is on the verge of collapsing start to unload stocks to avoid losing money. However, as the pace of share price decline picks up, panic begins to control the market driving other to follow suit.   

Groups of people taking their money out from banks, or rushing to sell all their stocks and other assets all at once lead to economic confusion and worsen any current economic unsteadiness.

Stock market crash and panic occurs by the end of an extended bull market. This is when extremely strong enthusiasm has lifted stock prices to new levels. By this point, prices are already higher than the actual value of the companies as measured by earnings.

Going back in time…

The Great Depression (1929)

The stock market crash of 1929, which resulted from an economic collapsed and panic selling, triggered the Great Depression.

Share prices lost as much as 25 percent at that point, taking away $30 billion in market value within the span of four days, starting October 24.

Black Monday (1987)

Black Monday, which was also mainly caused by mass panic, pulled the stock market index down by about 22 percent in October 19, resulting to a $500 billion loss in just a single day and making this the largest one-day percentage loss in stock market history.  

This was then followed by a 45 percent rally earlier that year, raising concerns of an asset bubble.

The Great Recession (2008)

This crash took place in the housing and real estate market. The Dow on September 29 experienced a 700-point decline, marking as its biggest drop in the history of New York trading.

How to prevent a stock market crash

  • Implement trading curbs or circuit breakers
  • For large entities, buy large amount of stocks
  • Keep a well-diversified portfolio
  • Re balance from time to time
  • Sell high and buy low
  • Keep costs small

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