Market Crash: Know about all the Stock Market Crash
Created on 03 Jan 2023
Wraps up in 10 Min
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The global economy teeters on the edge of a recession, with interest rates rising and the dollar going on a run to leave other currencies behind. Shareholders around the world cannot help but wonder if their funds and portfolios are safe or if a bloodbath is on the horizon.
Bloodbath how? Well, we all are aware that the stock market is well known for being quite volatile. However, volatility is more of a seesaw in the stock market and is somewhat expected.
A stock market crash is not a daily phenomenon. It is an event where stock prices see a drastic, unforeseen and alarming fall. Investors lose a large sum of money as a result of the fall in prices. This usually happens due to various factors related to the world economy.
The most recent stock market crash we all experienced was during the global pandemic of Covid-19. However, in this crash, a few stocks in the healthcare sector, natural gas sector and software sector did not crash. After all, during the pandemic panicked and purchased medicines as soon as they sniffled a little. This may have contributed towards the healthcare sector staying afloat. Similarly, as all the offices started working from home, the demand for laptops and computers increased, and the software sector thrived on the need for applications that would support the work-from-home setup.
What Is a Stock Market Crash?
A stock market crash is when there is an unexpected rapid fall in stock prices. This leads to the entire market falling and is hence, referred to as a market crash. A market crash may be caused due to one or several reasons like a global catastrophic event, the bursting of a large speculation bubble or an economic crisis.
Now, no threshold can be specified as a stock market crash, but usually, it is a double-digit fall in a stock market index. As soon as this happens, most of the investors start panicking. This contributes to the market falling further down as investors start to panic sell. This is because investors want to minimise their losses and think that selling their holdings before the market falls further might mitigate their loss. The mass-selling acts as a representation of falling demand, and when demand falls, prices follow. This results in the formation of a vicious circle, and the crash becomes more severe.
It is a fact that the price of financial securities will not keep rising forever. After years of enjoying a bull market, the investors have to experience a bear market. A few of the previous stock market crashes that went into the bear market were the 1929 Great Depression, the 1987 Black Monday, the 2001 Dotcom Bubble and the 2008 stock market crash.
With so many cyclical and circular events, you could say that the stock market has its own "circle of life" (cue The Lion King music).
Reasons For A Stock Market Crash
Often, stock market crashes are experienced when the financial markets have experienced growth and seen a rise for a long period. A stock market crash may be instigated due to several factors. Here are a few of the reasons for a stock market crash:
Panic Among Investors: When the price of stocks starts to go down, the investor's panic starts to go up. They start thinking of scenarios where their investment will significantly fall in value further. This leads to them panic selling most of their investments, as mentioned above. As multiple investors start following the same mentality, the sale of stocks reaches huge numbers, and that provokes a market crash.
Man-made Or Natural Calamity: A man-made calamity includes things like war, riots or acts of terrorism, while natural calamities include floods, earthquakes or a global pandemic.
The Coronavirus pandemic is an example of a natural calamity that is the most recent in our memories. As the virus spread throughout the world, people's lookout towards highly infected countries started changing. People knew that this unfavourable condition would not be play well for the global financial markets. Hence, the panic went up.
Economic Crisis: If an industry or one section of the economy sees a problem, there is usually a ripple effect. A ripple effect means that an issue starts spreading from one section to another in a quick manner. Let’s take the subprime mortgage crisis of 2008. The deregulation of the banking industry caused the mortgage to go up for high-risk borrowers. As a result, they started making payment defaults, which lead to the lenders selling off the defaulters' properties to recover their funds. These sales eventually lead to a fall in home prices and the housing industry's downfall. This entire event leads to a fall in the Dow Jones Industrial Index by 678.91 points. This fall was one of the biggest one day faced by the index in a single day.
Speculations: When many investors start investing in a particular sector, they often speculate positive returns. They start building very high expectations, leading to a bubble. But, if the sector's performance does not meet expectations, the bubble bursts and the investors start selling off their holdings. This leads to a market crash.
Inflationary Changes: When the inflation rate rises and gets very high, the borrowing cost goes up. This leads to less investment in the stock market, and many investors also prefer selling their holdings to get some cash to meet their expenses. This may cause the stock market to crash.
Stock Market Bubble
A stock market bubble is when an asset's price rises to an extremely high level within a short period. During an asset bubble, the asset's price goes well above its intrinsic value. Intrinsic value is the price that an asset is worth (read: Aukat).
But like all bubbles, even a metaphorical one in terms of stocks, bursts. And with it, people's money and dreams go *pop*!
A stock market bubble goes through 5 stages. Let’s discuss them:
Stage 1: Displacement
In the first stage, there may be a series of events that lead to the development of positive outlook regarding asset pricing in the mind of the investors.
Stage 2: Boom
The displacement stage causes the price to increase a little bit. However, as all the investors know about it, they start speculating and investing in it, which shoots up its price.
Stage 3: Euphoria
In this stage, the investors do not invest rationally. The excitement developed from the rocketing asset prices makes them invest in it. Some investors are ready to pay any price for the asset. They stop feeling scared about losing money; they think that the asset in question will make them rich and so, they buy it.
Stage 4: Profit Taking
Investors who understand that the asset bubble will burst start winding up their investments and realizing their profits. This marks the entry into the next stage.
Stage 5: Panic
In this stage, the investor's hope that the asset price will go up is substituted by the urge to panic sell the asset. Panic selling makes the bubble burst and the asset price starts crashing at an exponential rate.
Every rise in the price of an asset cannot be considered a stock market bubble. However, if the stock price goes beyond its intrinsic value and you observe that the cycle follows a pattern of the stages of an asset price bubble, then it may be possible. But, it is impossible to pre-empt an asset bubble and understand if and when the prices will crash.
Biggest Stock Market Crashes
Given below is a list of the biggest stock market crashes the world economy has ever witnessed:
- The Wall Street crash of 1929
- The Black Monday crash of 1987
- The stock market crash of 2008
- The crash of the Chinese market in 2015 and 2016
- The market crash of 2020 because of the pandemic
Wall Street Crash Of 1929
This crash began when the stock prices in the United States started falling in late October 1929. Within four business days (24th October, Thursday to 29th October, Tuesday), the stock market index in the US fell. The Dow Jones Industrial Average, the index with 30 listed companies, displayed a 25% fall in stock prices.
The main reason behind this is a long period of speculative activities. During this period, a large number of people invested their money, which shot up the stock prices. Then came the obvious and market-shaking decline.
But what brought about this certain change of heart? Apart from this, the reason was a minor recession in the summer and the tightening of interest rates because of a hike by the Federal Reserve. All this contributed to the investor's panic.
Black Monday 1987
After the Wall Street crash of 1929, the US investors always feared another market crash. In 1987, their fear turned into reality. On Monday, October 19th, 1987, the US stock market crashed by 22.6%. There was a massive fall in the Dow Jones Industrial Average and this day came to be known as Black Monday.
However, the loss in percentage terms was less than the previous crash that the US economy had witnessed. The reason being the US Federal Reserve's intervention in the market to cut down the interest rate in order to maintain market liquidity. A fall in the interest rate made the lending go up, and the Federal Reserve also conducted open-market purchases.
Fool me once; shame on you… So what fooled the US economy twice? It was primarily because the Federal Government announced that the country had a massive trade deficit, much more than they expected. This caused the value of the dollar to fall. Additionally, the Dow Jones Industrial Average displayed growth of 44% in the first 6 months of that year. This spiked the inflow of investments in the country. Also, the US markets introduced a new product called ‘portfolio insurance’ that extensively used options and derivatives. A 9% fall of the Dow Jones Index triggered these options-based insurances to send a sell signal. Mutual funds started to sell shares to be able to redeem their investors' need and triggered more selling. Ergo, a crash.
The Ketan Parekh Scam of 1992
The first major market crash was the Harshad Mehta Scam of 1992. In this, the market fell by 12.77% approximately. During that time, the banks were not allowed to trade in the stock market, so he convinced the banks to transfer the funds to his personal account. With this capital received from the banks, he invested in stocks, causing their prices to shoot up. He committed a ₹5,000 crore scam that caused a lot of investors to lose their entire life savings. The market lost 40% of its combined value. The aftermath of this event was the loss of investor confidence.
The Dot-com Bubble of 2000
2000 marked the turn of the millennia, and with it, the world ushered in the internet. Like any tech based bubble, the novelty of the internet was at the heart of this financial mishap.
Many online businesses had started up and the internet, thanks to its "new shiny" status allowed these businesses to source funds for themselves from venture capitalists. While some of these businesses had capable leaders at their helms, a lot of entrepreneurs were not running very strong businesses.
So, as the bubble burst and there was no more cash to burn, multiple businesses started to fall of the face of the internet. Some prominent casualties of this tech bubble were Boo.com, Webvan and Pets.com. Yeah, there is a reason neither you nor I have heard of them.
But it was not all doom and gloom. Some of the survivors of the 2000 "netpocalypse" are Amazon, Google and even Cisco Systems. Cisco Systems did suffer an 80% capital erosion, but it made it out alive.
2008 Stock Market Crash
The 2008 stock market crash already faced a few triggers, like the Dotcom bubble of 2000 and the 9/11 attack that took place in 2001. The Federal Reserve brought down the borrowing rates from 6.5% in 2000 to 1% in 2003. They had an intention of boosting the economy by offering lending at a low borrowing cost.
However, lenders started using it to get home loans at a mortgage rate of just 1%, and home prices skyrocketed. This led to the banks selling off these loans to the Wall Street banks. They moved them into mortgage-backed securities and collateral debt obligations.
After that, the Securities and Exchange Commission extended a relaxation of the net capital requirements for five investments bank in 2004. Slowly, the interest rates started going up again, and the buying of homes stopped. However, in 2006, home prices started coming down again. The citizens who bought homes earlier were disappointed as the prices were lower than what they had paid.
In 2008, the backbone of Wall Street, Bear Stearns, crashed, and JP Morgan took over it for just pennies. By the end of this year, the entire US economy faced a recession and saw the largest bankruptcy in their country’s history, the collapse of Lehman Brothers.
The 2008 stock market crash was not limited to the US. The Indian markets were also impacted by this. Our index, Sensex, saw a massive fall within a matter of a few days only.
2020 Stock Market Crash
The biggest stock market crash that India has witnessed was not long ago. It happened at the beginning of the Coronavirus pandemic. 23rd March 2020 marked the declaration of the Coronavirus lockdown by the government of India. It made the investors question the future, and they all knew that something bad was coming. Owing to this, Sensex and Nifty both fell by about 13%. However, this was not the end of the fall. The market fell from around 42,000 to 28,000 in just a week.
The Bottom Line
It is not possible to stop a market crash, but you can always minimize its impact on your funds and portfolio. The important thing to remember is that you should diversify your entire portfolio into different asset classes because we all understand how delicate the financial markets are.
By reading this article, you may have understood that panic selling may not be a very good option when the market is going to crash. So, try to stay calm and evaluate your next action rationally.
If anything, think of a market crash as a discount sale on your favourite stocks! If a company is fundamentally strong, as a negative market condition passes, you are set to gain from a rise in the fallen prices.
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