Stock Market Crash is a spontaneous dip in stock prices, resulting in a significant loss of public wealth. During a stock market crash, the stockholders panic sell the stocks to avoid more financial losses. This can happen due to socio-economic events like wars, changes in laws and natural calamities.
There is no exact definition for a stock market crash, but generally, it means more than a 10% decline in stock prices in a span of some days. Two main indications of a stock market crash are panic selling and an abrupt decline in stock prices. For example, During September 2008-09, several banks in Europe and America failed, causing a dramatic fall in stock prices in the world. Stock market crashes are not common, but they have a large economic impact.
India suffered its first-ever stock market crash in 1865. This was before the formation of the BSE(Bombay Stock Exchange). During 1861 the American Civil war had started, because of which there was a huge demand for cotton. India was the biggest exporter of cotton, so the cotton-producing companies in India soon became highly profitable. People started investing their excessive income in the stock market. During this period the cotton prices were sky-high, also the stock prices of companies related to cotton production and export were increasing rapidly. But in April 1865, the American civil war ended and the demand for cotton declined. This ultimately resulted in a sharp decline in stock prices in India. During this time there was no systematic way for trading stocks, but in 1875, the Bombay Stock Exchange was created, which was also the very first established stock exchange in Asia.
The Stock market crash on September 3, 1929, to July 8, 1932, is considered one of the biggest stock market crashes. During this crash, the market fell by 89.2%. Many stock market exchanges like New York Stock Exchange had no stock buyers during the crash, many companies filed for bankruptcy.
The stock markets have suffered from many crashes over the years, there are a lot of reasons associated with such crashes like terrorist attacks, new rules and regulations, political instability etc. When the crash continues for a longer duration of time, it will result in an economic recession. When the stock prices crash there is an immediate fall in the demand for products, causing lesser revenue for corporations. Because of such an economic crash, mass layoffs become more frequent, this slows down the economy.
What is the Stock Market Crash?
A stock market crash is a spontaneous and abrupt fall in stock prices across major sectors of the stock market. The impact of the stock market crash intensifies due to the panic selling of assets by shareholders to prevent losses.
This crash in market price is due to major events like changes in laws, terrorist attacks, political instability and the fall of a speculative bubble. The stock market crashes can also result in bear markets, as the stock market slows down because of an immediate fall in prices. When the stock prices fall for a longer duration after a crash, it will cause a recession.
Selling shares immediately after the drop and buying too many shares before the crash are some of the scenarios in which investors can lose huge amounts of money during the market crash. Long-term investors should restrict themselves from doing anything during a market crash. As the overall position of the stocks would be stabilized after the crash gets over. The market crash provides an opportunity for long-term investors to buy the shares at a very low cost during the dip.
The major stock market crashes include the 1929 market crash, the 1992 Harshad Mehta scam, the financial crisis of 2008 and the covid-19 crash of 2020.
History of Worst Stock Market Crashes
A stock market crash is defined as a double-digit decline in share prices within a few days. All the stock markets are highly volatile, still, market crashes are not common. Although the market recovers after the crash, the duration of recovery depends upon the intensity of the impact on the economy. Following are examples of some of the worst stock market crashes:
Kipper und Wipper
Debased (fraudulent) foreign coins issued in the Holy Roman Empire from 1621–1623 in order to collect cash for the outbreak of the Thirty Years’ War triggered one of the first stock market disasters in human history, known as Kipper und Wipper.
The term “weighing scales” alludes to the practise of removing coins that had not yet been debased from circulation so that they might be melted down and combined with cheaper metals like lead, copper, or tin before being reissued.
Tulip mania bubble
The Tulip bubble is considered the first speculative bubble which was observed during the Dutch golden age. During 1634 the prices of Tulip bulbs started increasing exponentially. These tulips were considered a luxury item and because of which they were expensive.
As per some reports, during the peak of tulip bubble mania, Tulip bulbs were sold 10 times the average income of skilled artisans in the country. But unfortunately, in 1637 the prices of tulips dropped unexpectedly causing a huge market crash. This event gained the attention of economists after the publication of the book Extraordinary Popular Delusions and the Madness of Crowds(1841) by Charles Mackay. As per Charles, this event had a disastrous effect on the Dutch economy. But as per the new research by economists, it is believed that this event had just a small impact on the economy and was not that much of a disaster as described by Charles.
The Bengal Bubble
The Bengal bubble was caused because of overvaluation of the East India Company. Due to this bubble burst, there was a massive economic crisis in 1769. The company’s shares were trading at £284, but during 1784 it suffered a decline of 55% to £122. The Bengal famine and the attack on the company’s holding are the main reasons for the crash.
The great Bengal famine was so massive that it affected around 30 million people in the regions of Bihar and Bengal. The main reason behind the Bengal famine was drought and policy failure. Several attempts were made to reform the company after the crash but because of the uncertain conditions in England, the reform never took place before 1784.
Panic of 1792
The extension of credit by the newly founded Bank of the United States and the reckless speculation of William Duer, Alexander Macomb, and other important bankers in March and April 1792 triggered the financial credit crisis known as the Panic of 1792.
The bankers had intended to increase the value of US debt instruments and bank stocks, but their failure on loan payments caused the value of these assets to fall, which in turn triggered a bank run. Concurrently, the Bank of the United States tightened credit, which exacerbated the initial panic.
Black Friday
It was a gold panic on September 24, 1869, called “Black Friday,” and it was caused by the attempts of two speculators, Jay Gould and his colleague James Fisk, to corner the gold market on the New York Gold Exchange.
The stock market crashed that day when the scheme was exposed. Ulysses S. Grant’s programme of selling weekly Treasury gold to pay down the national debt, stable the currency, and stimulate the economy was at the centre of the scandal that rocked his administration.
Depression in Europe and North America
This financial crisis created economic instability in the European and North American regions from 1873 to 1879. In Britain, the depression was a result of two decades of weakened economic leadership. Before the crash, the initial symptom was the economic failure of Vienna. This panic was known as the Great Depression in America as it was considered one of the biggest economic failures during that time.
The various other reasons responsible for this panic were American inflation, the demonetization of silver in Germany and the United States of America, and the great Chicago and Boston fires. All of these incidents increased the strain on the banking system. The banking reserves of New York City declined from $50 million to $17 million during this phase.
Encilhamento
The Encilhamento was a significant economic bubble that rose in the late 1880s and early 1890s, and its subsequent collapse was one of the biggest stock market catastrophes in Brazil’s history. The Brazilian government’s finance ministers devised a strategy of unlimited bank loans for manufacturing enterprises, bolstered by a flood of new currency, to spur the country’s economic transformation into an industrial powerhouse.
This economic incentive strategy led to unchecked speculation, higher inflation, and a rise in the number of phoney IPOs and hostile takeovers.
Panic of 1893
The United States experienced a severe economic crisis known as “The Panic of 1893,” which lasted from 1893 until 1897. Every part of the economy was hit hard by the downturn, and the resulting political turmoil helped usher in William McKinley’s realigning election and presidency in 1896.
The panic caused a precipitous drop in stock values, the closure of 500 banks, the failure of 15 thousand of enterprises, and the closure of many farms. In Pennsylvania, it reached 25%, in New York it reached 35%, and in Michigan, it reached 43%.
What are the 3 factors that cause the Stock Market to Crash?
Stock market crashes depend upon a lot of factors like wars, political issues, news and natural disasters. All such factors determine the condition of the stock market. For example, during the COVID-19 (2020) outbreak, the coronavirus was responsible for the market crash. Similarly, The market crash of 1769 was determined by an external factor, the Bengal famine. These factors do not have a direct relationship with the stock market but still, they impact the psychological behavior of shareholders.
1. Speculation
Speculation in the field of economics is defined as the act of trading in the higher risk zone to gain maximum profit. Speculative investments are having huge risks associated with them, and the investors in such cases are focused on price fluctuations. The investors in this scenario expect profits in the long term.
2. Panic Selling
Panic selling is defined as the large-scale selling of stocks, causing an immediate decline in the price of stocks. Panic selling is governed by panic and fear of the investors. In this case, investors are driven by human emotions rather than an overall analysis of the stocks. Most of the stock markets employ various methods to avoid panic selling like trading curbs. Trading curbs are also known as circuit breakers, the main of this is to avoid market crashes by normalizing the market. The NYSE uses a three-layer circuit brake system (Level 1,2,3). These levels are determined by the percentage drop in S&P 500 Index. Panic selling storms the market with excessive shares, which reduces the price of all such shares. The economic crisis of 2008 is one such example of a market crash caused by panic selling.
3. Bubble
A bubble in economics refers to the situation in which a particular stock or investment is overvalued by a larger margin as compared to the original price of the stock. The price of the stock is overvalued because of the speculative demand by the shareholders. Such bubbles burst when people realize the overvaluation of the stock triggering mass selling in the share market. This creates a situation of panic, so it also gives rise to panic selling, ultimately resulting in dramatic price drops. So a bubble burst can act as a major factor in initiating a share market crash. The dot com crash of 2000 was an example of a bubble burst that created a massive economic crisis in the USA. Similarly, in 2008 the real estate bubble created a massive recession worldwide.
What are the Worst Stock Market Crashes in the 19th and 20th centuries?
Whenever the stock market experiences a crash, it affects the investor’s mindset by making them act in fear to sell off shares. The stock market crashes have a severe impact on economic stability. These crashes can last for days to months. These crashes are indirectly affected by external factors that create panic in the investor’s mind. The very first economic crashes were observed in the 17th and 18th centuries, after which the world experienced different kinds of economic crashes. Following are Some of the examples of the worst stock market crashes of the 19th and 20th centuries.
1. 1929 stock market crash
The crash of 1929 is also known as the Wall Street crash, it is considered one of the major market crashes in America. This crash started in September and ended in October 1929. This crash was initiated because of the fear of speculation by the federal reserve. 24 October 1929 was the most disastrous day of the crash because it had the highest selloff in a single day.
Around 16 million shares were traded on the New York stock exchange during that day. This crash initiated The Great Depression; it was also responsible for the London crash that took place in September 1929. The effects of the crash continued till 1932, during the Great Depression few of the stocks even lost 90% of their value.
2. Black Monday crash of 1987
During the Black Monday crash of Oct. 19, 1987, The American markets declined by more than 20% in just a day. The main cause behind the crash was program-driven trading models.
During the crash, all the major 23 stock exchanges suffered massive financial losses. The most affected stock exchange was Hongkong with a decline of more than 45%.
3. Dot-com bubble of 1999-2000
The dot com bubble burst happened because of huge investments in technology and internet-related companies during 1999. Because of the hype, the share values rose to their maximum during March 2020.
The crash happened in December 2020 resulting in a 50% loss in the share prices of technology companies. It was only after 2017 as the company regained their value. As per a few studies, the crash wiped out 5 trillion dollars worth of investors’ money from 1999 to 2000.
4. Stock Market Crash of 2002
This market crash was observed in the US, Canada, Asia and Europe in March 2002. The NASDAQ lost 80% of its value and S&P 500 lost around 50%, which greatly impacted the economy.
The September 11 tragic terrorist attack was also one of the factors responsible for the crash. Just after the dot com crash, many companies were facing bankruptcy like Exodus and Pets.com. NASDAQ suffered a loss of $9.3 trillion during the whole phase.
5. Financial crisis of 2008
Businesses, economies, and stock markets all suffered negative effects from the 2008 financial crisis. The Sensex fell by roughly 1408 points on January 21, 2008, depleting investor wealth. This day is also called Black Friday. In 2008, the stock market plummeted as a result of a large number of people taking out loans they couldn’t afford.
Lenders loosened their rigid credit requirements in order to grant loans to borrowers who didn’t meet them. As a result, housing costs increased to amounts that many people could not normally afford.
The 2020 coronavirus crash is the most recent market crash. It happened during March 2020, and the main cause behind the crash was the economic slowdown due to the outbreak of coronavirus. The decline in share prices was so immediate that various stock exchanges halted trading. DJIA lost 37% of its value because of the crash.
Various stock exchanges fell by 20 to 30 per cent. But the markets were able to regain the previous momentum after the crash in 2-3 months. During August 2020 S&P 500 was marking record highs.
How do they determine when Stock Market Crashes?
Generally, stock market crashes are triggered by catalyst incidents that create a panic of selling among shareholders, Which results in a rapid decline in share prices. This momentum is carried forward by the investors because of the fear of selling to minimize losses. Stock market crashes do not happen overnight, these crashes can be predicted with the help of indicators. For example, the 2008 crash was not just because of the failure of the Lehman brothers, this incident just triggered the crash. In actuality, the crash was because of the instability of economic activities in the United States of America for a long time. The stock market exchange is responsible for determining the early indicators of a market crash. They utilize various methods to halt trading in case of massive price drops. This is done to normalize the conditions so that the stock market does not suffer a crash.
Circuit Breakers: These are also known as trading curbs, the purpose behind using circuit breakers is to prevent trading activities during a situation of panic among investors. This is used to avoid scenarios of panic selling, by giving time to investors to digest the news. For example, the New York stock exchange uses a three-level circuit break system to avoid panic selling. This three-level system is initiated depending upon the decline in the percentage of the S&P 500 Index.
Plunge Protection: This is defined as purchasing large quantities of a particular stock to curb panic among individual investors. During the panic of 1907, GP Morgan was able to convince big Investors to buy their shares to avoid a significant price drop. But this method is not a proven method and can also be ineffective.
An Extended Bull Market: It is often believed that the market is a well-balanced system; but, in practice, the market is everything but well-balanced. As long as bears and bulls continue to argue their respective positions, the stock market will have a difficult time maintaining stable values on a daily, monthly, and even annual basis.
When bulls dominate the market for an extended period of time, the prices that investors must pay to hold shares skyrocket, which in most cases results in exorbitant overvaluations. On the other hand, excessive dominance by bears may drive stock prices to plunge, which in turn leads to significant undervaluations.
In point of fact, active traders make it their life’s job to capitalize on the unstable equilibrium of the market.
Consider the length of time that the market’s trend has been moving in an upward direction. The duration of a typical bull market, as reported by Forbes, is around two years and seven months. If the bulls continue their winning streak without interruption for an extended period of time, this can be a warning indication that the market is about to turn.
The Buffett Indicator: The Buffett Indicator is a fundamental measure of whether the stock market is under or overvalued as a whole. It was first proposed in 2001 by the iconic investor Warren Buffett. Since then, the indicator has been used by economists and Wall Street experts almost religiously.
The indicator compares the total value of the U.S. stock market to the U.S. gross domestic product or GDP.
According to Buffett himself, the market is valued fairly when the indicator is somewhere between 75% and 90%. Once the indicator climbs to between 90% and 115%, the market is modestly overvalued. Finally, any time the indicator is over 115%, the market is highly overvalued and poised for significant declines.
So, what does that say about the market in 2021?
As of September 29, 2021, the indicator sat at more than 239% according to Current Market Valuation, suggesting that the market is overvalued to an extreme, and dramatic declines are likely ahead.
What will happen when the Stock Market Crashes?
When the stock market crashes, there is a situation of panic and fear in the community causing investors to sell their assets at a lower price. When such a crash occurs the market gets flooded with assets and securities. There is instability in the demand and supply ratio, and the demand for shares declines at a rapid rate. During this phase, the investors are driven by human emotions rather than analysis of the stocks. Because of the fluctuating prices investors can lose a huge amount of money if they plan to sell their assets during the dip. For example, suppose an investor has 1000 shares each worth $2.5, but due to the crash, the price of individual shares drops to $1. Then the overall worth of the shares becomes $1000, if the investor plans to sell during the dip, he would lose $1500. However, if the investor does not sell during the crash by avoiding panic in the market, the shares can regain their original value over a long duration of time.
When the Stock Market Crashes, what do investors do?
When the market goes down, The entire value of the investment drops. This creates fear among the shareholders, then in order to minimize their losses shareholders try to sell their shares. A bear market can result from a stock crash when the market declines by 10% or more after a correction, for a total decrease of 20% or more. Recession may be brought on by a stock market crash. If stock prices fall sharply, corporations won’t be able to expand as much, which would lead to bankruptcy. A decline in demand eventually results in less income, which causes more workers to be laid off. As a result, the economy shrinks and a recession is created.
What can people do during a Stock Market Crash?
Stock market crashes can heavily impact the value of the assets owned by the people. Market crashes are uncertain situations driven by factors like news rumors, natural calamities, economic failures etc. The factors are not directly related to the share market but they somehow affect the mindset of investors creating a decline in demand for stocks.
- Avoid panic selling
Incidents such as news of pandemics or some scams being revealed create a situation of panic among investors. As per the studies, the best and worst performing days of the stock market are relatively close to each other. So investors should resist selling their assets during the crash as it would result in further worsening the situation.
- Create an Emergency Fund
Emergency funds can be very helpful during the time of a crash. Crashes create a short duration of shortage of funds, to avoid financial issues, investors should make emergency funds for about 2-3 months. This reduces the urge to sell assets during the crash.
- Avoid panic buying
Similar to panic selling, buying can also be a disaster during a market crash. Investors generally try to invest in stocks at lower prices to sell them at higher prices. But the market crash is an unexpected situation, the value of assets can decline further. Ultimately resulting in intensified losses. Investors should do proper analysis before buying and selling stocks during the crash.
The COVID-19 crash also referred to as the Great Lockdown started in February 2020, this crash resulted in a global recession. This was due to the slowdown of the economy, the first major indications of the crash were the immediate decline of major stock exchanges by 20 to 30% during February and March. This crash created a rapid imbalance between the demand and supply of goods and services. This ultimately resulted in a slowdown of the economy and massive unemployment. Infrastructure and luxury goods were the most impacted sectors during the crash. Various steps were taken by the respective governments to ensure a faster recovery from the recession. Rules and regulations were made to promote economic activities, keeping the safety of the individuals in mind. Interest rates were cut so that financial aid can be provided to small businesses. By November 2020, the US markets were back to a normal state as they were before the crash. The market has been successful in recovering from the impact of the coronavirus crash, because of the effective decisions taken by the respective governments. The below charts show how much the indices have recovered since the crash.
You can see that Nifty has managed to offset the coronavirus crash.
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The same is the case with S&P 500 index. It has also managed to offset the overall covid 19 effect.
