What Causes A Stock Market Crash, And How You Can Protect Yourself

What Causes A Stock Market Crash?

A stock market crash is characterized by a sudden, dramatic decline across the broad market, usually in the form of a double-digit percentile decline. It is important for investors to understand what causes a stock market crash, and what can be done to protect your self from the inevitable volatility in any market.

While the circumstances surrounding each market crash have been different, the underlying reasons for a stock market crash usually manifest long before the actual crash, and normally go unnoticed by investors.

A stock market is particularly susceptible to a crash following periods of excessive market speculation, high stock valuations and P/Es, and investor optimism. Often times the crash is the result of a specific trigger – a news even or government report – that marks an end to an unsustainable trend.

What Causes A Stock Market Crash? Historical Crashes And Their Causes

When investigating what causes a stock market crash, it is important to keep in mind the social and economic climate of the times. The stock market crash of 1929 signaled the end of a prosperous time in the history of the United States known as the Roaring Twenties. As more and more investors entered the market, and sentiment and optimism were high, the market grew to previously unseen heights.

As the exact cause for the sudden crash of the market on Black Thursday in October of 1929, and the subsequent crashes that followed over the course of the next several years has been the subject of intense debate, the prevailing theory is that the market was susceptible to even the slightest downturn due to the high use of leverage by investors.

When the market eventually turned on investors, a panic ensued, shutting down lines of communication and causing a massive crash across the major indices. This series of events put in to motion the economic problems that led to the greatest economic crisis in modern history, the Great Depression.

The Great Depression ushered in an era of increased government intervention in the economy, as well as increased Wall Street regulation and oversight. These regulations have since prevented a crash of the same magnitude seen in the late 1920s and 1930s, although the market has crashed since then, most notably Black Monday in October of 1987, the dot-com bust, and the bursting of the housing bubble in 2008.

By Learning What Causes A Stock Market Crash You Can Protect Yourself And Your Portfolio

By finding out what causes a stock market crash, you can better learn to recognize the signs of an impending crash, and position yourself to ride out the volatility. Throughout each of the historic stock market crashes, it would have taken nerves of steel to invest in the market, but history has proven that with a long-term investment plan, those investments would have produced incredible gains.

It has been proven that by taking a long-term view, utilizing dollar-cost averaging, and reinvesting dividends an investor can realize gains in the market, and beat the rate of inflation. Maintaining a balanced, age-appropriate mix of stocks and bonds has traditionally been the path to successful investing.

The very nature of the stock market lends itself to volatility, both mild and extreme, and investing carries innate risks not seen in other types of secured investment vehicles. Understanding these risks and planning for them, as well as being aware of factors that weigh on the market can be valuable tools in building and maintaining wealth in the stock market.