What is a stock market crash? All you need to know
Highlights
- A stock market crash is an abrupt slump in the prices of stocks in the equity market.
- Limitless rise of a stock price gives rise to a bubble scenario.
- Pandemic expedited the crash at an unexpected pace.
A stock market crash is an abrupt slump in the prices of stocks in the equity market. In real terms, there is no numerical threshold that can define a market crash. Speculative elements, economic conditions, or catastrophic events can be a reason behind this sudden price fall. This may happen in a single day or may take several days. Once the market crashes, it severely impacts the economy and the investors.
When a majority of the stocks are impacted by the situation, it tends to pull down the entire market. Further, it brings along several downturns and triggers an extended version of a bear market. The panic-stricken investors begin to sell off their stocks which further exacerbates the situation.
Causes of Stock Market Crash
Bubble Bursts
In any economy, when the prices of stocks keep on increasing limitlessly, it gives rise to a bubble scenario. In this, the indexes reach an all-time high, and the Price/Earnings ratio crosses the all-time high.
Collectively, this forms a bubble as there is huge money poured into the market. At this moment, negative news can create a panicky situation and can burst the bubble which is followed by a market crash.
Terrorism being is prevalent at a global level, can lead to a market crash. For instance, the Act of terrorism at the World Trade Centre, USA, led to a crash worldwide. So, in case of any terrorist activity, it can create panic in the stock market making the whole country suffer.
Several times, there have been market crashes due to huge scams. With a scam going on, it lowers investors’ confidence which has a negative impact on stock prices. A market crash can take up to several months to recover and come back on track.
With higher interest rates, the cost of borrowing rises and weakens the purchasing power of individuals. Further, it leads to a highly volatile market environment. This anticipation of high debt can make investors sell their stocks leading to a sudden fall in stock prices.
Pandemics can cause a crash at a much faster rate than expected. The outbreak of novel Coronavirus (Covid-19) caused several uncertainties in the market. It caused distrust and fear among investors that invariably led to a stock market crash.
Recession vs. Stock market crash
A recession is considered as an economic slowdown whereas a stock market crash is a result of panic. When a country’s GDP is negative for two consecutive quarters, it brings in recession. A recession may recover in the third quarter. Whereas a stock market crash takes a lot of time to recover and has massive impact on the existing wealth of the investors and the country as a whole.
Bottom Line
Rising inflation and overheated economy are some of the major factors that lead to a market crash. A single factor or a combination of these may bring unexpected changes in the market.
The fall enters gradually and meets a dreadful peak in the market as investors intend to sell off the stocks. Hence, it is crucial to have appropriate knowledge of the stock market before entering and investing in it.
Please note, the above content constitutes a very preliminary observation based on the industry and is of limited scope without any in-depth fundamental valuation or technical analysis. Any interest in stocks or sectors should be thoroughly evaluated taking into consideration the associated risks.
