Why Do The Stock Markets Crash?


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There is no quantifiable concept for a stock market crash., but it is commonly applied to steep double-digit percentage losses over several days in a stock market index. But before going into the details, you must understand what the stock market crash is?

The Stock Market Crash

In simplest terms, it is a sudden and dramatic drop in stock prices across a large portion of a stock market. Though there is no set threshold for stock market crashes, they are typically defined as a drop of more than 10% in a stock index in a single day or two.

Causes of the Stock Market Crash

If you ask different experts what causes a stock market crash, you will get different answers. A flood of academic research has also failed to provide a conclusive answer. Taking this into consideration, here are some of the factors that contribute to a stock market crash:

  • According to conventional financial theory, market participants act rationally, failing to account for investor sentiment, which can drive stock prices higher or lower. Investor sentiment is influenced by greed, fear, and expectations. Periods of high investor optimism can artificially inflate stock prices, creating a ‘bubble’ that has the potential to burst, causing share prices to fall dramatically.
  • Panic exacerbates a stock market crash. Typically, when investors believe the market will crash, they begin to sell stocks to avoid losing money. However, panic grips the market as the share price decline accelerates, causing others to follow suit. As everyone rushes to sell their stocks, supply exceeds demand, causing prices to fall.
  • Significant global or geopolitical events can erode investor confidence, urging them to sell risky assets in favor of safe bets like gold or bonds. Unprecedented events can cause panic-induced selling, resulting in a stock market crash. After the 9/11 terror attacks, the Dow Jones fell 7.52 percent in intraday trading when Wall Street reopened.
  • Investors are alarmed as signs of increased volatility in various risk assets and emerging markets emerge. Citigroup issued a warning earlier this week that stock markets could fall if the global economy slows. Investors should remain cautious, as strategists predict slower growth in China and mixed macroeconomic data from the United States.
  • Since algorithmic trading has been around for a long time, it has only recently dominated trading activity. Because there is no human input, algorithms can frequently cause or accelerate market price drops. According to the Bank for International Settlements, the “flash crash” in sterling last October was caused by unskilled traders, algorithmic trading, and complex trading positions.

End Words

There is no single reason or factor behind the stock market crash. Many factors can contribute to one, including economic optimism, increased price-to-earnings ratios, extensive use of margin debt and leverage by participants, wars, natural disasters, etc., and large corporate hacks. It is difficult to prevent a crash because there can be no prediction, but certain safeguards such as trading curbs and circuit breakers can help based on previous trends.