A stock market collapse is a sudden and unexpected decline in stock prices. A stock market fall can occur as a result of a large disastrous event, an economic crisis, or the bursting of a long-term speculative bubble. Reactionary public fear in response to a stock market fall can also be a key cause, prompting panic selling that further depresses prices.
Although no particular threshold exists for a stock market crash, they are typically defined as a sudden double-digit percentage decline in a stock index over a few days. Stock market collapses can have a big economic impact.
Causes of a Stock Market Crash
Many market collapses can be attributed to excessive speculation. The 1929 Crash was a stock market speculative bubble in general. The early-2000s tech stock crisis followed a period of excessive investment in dot-com businesses. Furthermore, the 2008 crisis might be related to investor speculation in real estate (and banks enabling the practice).
When things are going well, leverage (sometimes known as “borrowed money”) might appear to be a valuable instrument. For example, buy 5,000 worth of stock and it climbs 20%, the buyer will profit 1,000. If he borrowed 5,000 more and purchased 10,000 worth of the same stock, he would make 2,000, doubling the gains.
Leverage, on the other hand, may be quite hazardous when things are going against it. Assume if an identical 5,000 stock investment plummeted by 50%. It would hurt but still have 2,500. If one borrows a further 5,000, a 50% decline would have wiped him out. When things go wrong, excessive leverage may cause downward spiral inequities. As prices fall, businesses and investors with a lot of debt are obliged to sell, which drives prices further lower.
Rates of Inflation:
Economically, higher interest rates indicate greater borrowing costs, which tends to slow down purchasing activity, causing equities to fall. As a result, if the 30-year mortgage rate rises to, say, 6%, it may significantly halt the housing industry and cause homebuilder stocks to fall.
Markets like stability, but wars and political risk are the polar opposite. When there is uncertainty in the surrounding the next moves of the investors are spooked.
Deduction from the tax base of that portion of nominal income resulting from inflation. The nominal taxable income remains unchanged while the real taxable income falls with this technique. As a result, it will compensate for the consequences of inflation.
These can be only a few of the huge reasons, but it is mostly a combination of more than one factor.
Interaction of Bull Market, Bear Market, and Stock Market Bubble
A stock market collapse typically occurs when the economy is overheated, inflation is rising, market speculation is rampant, and there is significant uncertainty about the path of an economy. As a result of these factors, the stock market fall frequently begins as a trickle and finishes as a disaster as investors seek a quick quit or exit option. It might fall in unfavourable ways due to the strong interplay of the bull market, bear market, and stock market bubble.
It occurs when investors are bullish on the market and the economy, as well as when demand exceeds supply, leading to a surge in share prices. It might persist between 2 and 9 years. All it takes is a big market event to spark a confidence crisis and attract additional sellers to the market.
It frequently evolves following a stock market crash. In this case, investors become gloomy and begin selling shares, causing prices to decline as supply begins to outstrip demand. It is referred to as a bear market when the stock market loses 20% of its value in 52 weeks. It usually lasts for four years or fewer.
Stock Market Bubble:
It inflates and explodes when investors adopt a herd mentality and buy stocks in large groups, resulting in inflated and unreasonably high market values.
Effects of the Crash:
A stock market crash can result in a bear market, which occurs when the market falls by 10% or more after a correction, for a total drop of 20% or more. A stock market fall might cause a recession. If stock prices fall substantially, corporations will have less capacity to grow, resulting in insolvency. A demand reduction eventually leads to less revenue, which causes more people to be laid off, thus the decline continues and the economy collapses, leading to the formation of a recession.
Examples of Market Crash India
2015-16 was a difficult year for global stock markets. The Sensex in India continues to decline. By February 2016, it had plummeted by around 26% in just eleven months. This was largely attributable to Indian banks having a high level of non-performing assets (NPAs) as well as an overall worldwide downturn. People were frantically selling in November 2016 when the government cracked down on black money through the Demonetization effort, causing the Sensex to plummet by 6%. This occurred in tandem with losses in other Asian markets.
Also read: History of Stock Market Crashes in India
Stock Market Crash – FAQs
Q1. What is a market crash?
A stock market crash is defined as a quick and dramatic drop in stock prices over a large segment of a stock market, resulting in a considerable loss of paper wealth. Panic selling and underlying economic reasons drive crashes. They are frequently associated with speculative and economic bubbles.
Q2. What causes a stock market crash?
A market collapse can occur for several causes, such as poor economic news, other terrible news such as war or a terrorist attack, or simply a general perception that the economy is overinflated.
Q3. Can I profit from a market crash?
Yes, you can. You can profit when you look for stocks that pay dividends, diversify and shuffle and adopt other strategies that would work at the moment.
Q4. Are there any measures to prevent a sudden market crash?
Several safeguards have been used to prevent stock market collapses, including circuit breakers and trading limits to mitigate the impact of a precipitous drop.
Q5. When was the last market crash in India?
The last market crash in India was in 2016.