While stock market crashes tend to get a lot of attention, and can cause a considerable amount of financial chaos, many people are left wondering, how does a stock market crash?There are a variety of factors that can trigger a stock market crash, with psychological and economic factors playing the most prominent role.
A stock market crash is traditionally defined as a double-digit percentage drop is stock prices over a span of time. There have been stock market crashes that have taken years – such as the market crashes that began in 1929 and ended with a nearly 90% decline in the broad markets in 1932 – and some that have been confined to one trading session – as seen in the market crash of 1987.
Stock market crashes have also historically followed periods of excessive optimism and speculation, with the most famous example being the proverbial hangover from the party that was the Roaring Twenties, known as the Great Depression.
How Does A Stock Market Crash? Psychological And Economic Factors
When exploring the question, “how does a stock market crash?” it is important to remember that there is no one deciding factor, but rather a combination of variables that can lead up to a market crash. No two crashes are alike, and it is crucial for investors to weigh all mitigating factors in any type of market.
Investor sentiment can play the largest role in both a market boom as well as a market crash, as excessive buying and investor optimism can trigger a run up in stock prices, while negative investor sentiment can trigger an episode of excessive selling.
A market crash is most likely to occur when intense speculation and investor optimism combine to drive up stock prices considerably, usually within a relatively short span of time. When economic news turns unfavorable, or even fails to meet expectations, an episode of panic selling could occur.
As more and more investors flee the market, and margin traders are forced to close their losing positions, the downward pressure on the market causes a cycle that could lead to the crash of the market. In times of economic bubbles, such as the tech bubble and the housing bubble, the loss of wealth has been considerable.
How Does A Stock Market Crash And What Are The Lasting Effects?
Regardless of the long-term effects of a market crash one thing holds true for every crash throughout history – massive amounts of paper wealth has been lost. In the even of a severe crash, or one that is prolonged there could also be a decline in currency value and a rise in commodity prices leading to deflation.
Corporations and other institutions become susceptible to bankruptcy, and a sustained decline in investor confidence could lead the economy into a recession, or in extreme cases a depression. There some investors who take advantage of the low stock prices seen after a crash to buy up shares at a discount, and then sell them when the market stabilizes for a profit.
Having the understanding of how does a stock market crash is important for investors who want to safeguard their investments from market volatility. It is paramount for investors to remain educated as to the condition of the economy, the market, and the individual companies you have invested in in order to shield yourself from the inevitable ups and downs of the stock market – especially the downs.