A Stock Market Crash is when stocks are sold off in dramatic fashion. All major indexes, such as the Dow Jones Industrial, the S&P 500 and the NASDAQ decline rapidly. There is usually a reason for the sell off, but for the most part it is mostly a psychological reaction to an economic or political event as well as a stock market bubble where the market has increased substantially over the years or months preceding the crash. Once the selling starts, crowd behavior takes over and triggers more selling and the cycle continues until you have a massive sell-off.
It can be said that the reason stock market crash occurs is because of stock market optimism and a continuous rise in stock prices. In other words is going up too fast for its own good. That is something that happened during the Internet bubble back in 2000. People keep buying internet stock in companies that had not shown any earnings in prior quarters. So the bubble kept getting bigger and bigger until it popped.
A stock market crash is not followed or preceded by a bear market. A bear market usually last several months where the market declines over a period of months if not years.
The Crash of 1929
After WW1 the US enjoyed peace and prosperity during what was called the roaring 20’s. New technologies came into the market such as the radio and the automobile. The stock market soared as many investors began to buy shares of these companies that had the latest technology. Everyone got involved so much so that people started to buy shares on margin, which means that investors would borrow shares of a company in anticipation of the stock going higher. They would then sell, return the shares and pocket the difference. Everyone thought it was a great thing. However, the opposite is true, once you borrow these shares and the shares go down in price, not only do you owe the original shares, but you also owe the difference on the negative side. Oh boy….
Millionaires were created overnight and everyone wanted to be trader since the market did not go down. People went as far as mortgaging their homes, and investing their life savings in order to jump on the latest stock (boy this sounds so familiar, I guess history does indeed repeat itself). By 1929 the Fed tried to cool off the market by raising interest rates. The market slowly cooled, but it was too late, people started to sell and panic set in after the bubble burst. Margin investors were getting hammered as they tried to dump their stock holdings. People became bankrupt instantly and some even leapt out of buildings committing suicide.
Banks were also affected since they took deposits to invest in the stock market. Bank lost millions of dollars. People wanted to get their money out of the banks, but they couldn’t since the banks had no money. Banks and other financial institutions became insolvent adding more fuel to the stock market crash and the bear market. Shortly thereafter the depression ensued, which lasted until the beginning of WWII.
The Crash of 1987
Monday, October 19th 1987 also known as Black Monday saw the Dow Jones Industrial (DJIA) plummet 508 points a 22.6% lost in one day. The decline actually started the previous week on October 14th. At the end the DJIA lost a total of 760 points a drop of over 31%.
The stock market crash of 1987 was a worldwide phenomenon. Markets around the world were all affected by the crash. However, the market rebounded immediately, but it took two years before the Dow regained all of it’s loses on the dreadful day.
Till this day no one can say what caused the crash, but the market was a bit over extended similar to the 1929 crash. Similar characteristics were present, it was a bull market and stocks seemed a bit expensive. Interest rates were high, there was news about a declining economy, the dollar losing its value and a large trade deficit (similar to what we have going on presently in 2008) that may have triggered the sell off. One thing led to another and before you knew it investors started to sell. The crowd followed and the rest is history.
As a mechanism to prevent such crashes in the future, the market introduced a “circuit breaker” (shut down the market) to prevent a sell off on the NYSE. It is based on the idea that walking away, letting things cool off a bit would help investors calm down and thus prevent further market sell-off. The last time this happen was the day after September 11th when the stock market began a huge sell off again due the terrorist attack in NYC. However, once again we bounced back and made new highs. The US market and its economy are resilient and it will be for years to come. However, Chine and India are close behind. One thing is for sure, take advantage of these market sell off so you can jump back in the market to maximize your gains. But, in order to do this you have to have some cash on standby and ready to jump in when such rapid sell off occur. Don’t get me wrong, I don’t want market to crash, but global events will happen for sure especially in this date and age. If you educate yourself and keep tabs on what’s going on, then you will benefit from such declines. One thing is for sure, a stock market crash is no fun for a lot of investors. Always keep you eye on the ball and prevent yourself from becoming a victim of a crash.