What is a Market Crash?
A market crash is an unanticipated and rapid drop in prices of securities traded in the market. While prices of individual equities do experience rapid rise and fall in prices, a crash comes into play whenever a broad index of many related securities experiences double-digit declines.
There is no percentage decline used to define a market crash. However, double-digit crashes over a few days or even months are many at times referred to as a market crash.
Market Crash History
A notable market crash occurred in 1929 when a panic selling engulfed the stock market-triggering one of the largest falls over a period of two years. The market bounced back in 1932 after the Dow Jones Industrial average had lost more than 89% of its peak market value.
Another market crash started on October 19, 1987, in Hong Kong before spreading west to Europe. The Dow Jones shed a whopping 22.6% in a single day marking the index biggest drop in history. A slowdown in U.S economy growth and falling oil prices are touted as some of the reasons behind the 1987 market crash.
The most recent market crash occurred in 2008, often referred to as the great recession. The crash began with the bursting of the booming U.S housing market. Large amounts of mortgage-backed securities and derivatives lost a significant amount of value triggering ripple effect in the stock market, which consequently resulted in the wiping off trillions of dollars in stock’s value.
What Causes Market Crash
Speculation
Markets crashes are most of the time triggered by speculation. For instance, the crash of 1929 came about on speculation about a bubble burst in the stock market. The market crash in early 2000, on the other hand, came hot on the heels of intense speculation on dot.com companies. The 2008 market crash was fuelled by increased investor speculation on real estate.
Excessive Leverage
Too much leverage in the financial markets, can trigger a massive sell-off that is hard to control or avert in case things turn sour. Whenever prices drop, institutional investors with lots of leverage are many at times forced to sell their holdings a move that most of the time fuels a sell-off in the broader market.
Rising Interest rates and Inflation
While rising interest rates and inflation are a sign of a booming economy, at times, act as a negative catalyst for market crashes. Whenever interest rates rise, investors turn their attention to high yield investments such as REITs resulting in a potential bubble that may burst.
Political Risk
Markets like stability and whenever economic powerhouse like the U.S go to war, then there is always a probability of a market crash. The Dow Jones Industrial plummeted by 7% in the aftermath of the September 11, 2001, terrorist attacks in the U.S.
Trade Safely,
Alon