The stock market continues to change, as the prices of the stocks of various different companies change over time and affect the overall trend in the market. The stock market trends can be observed by examining the movements of various stock market indices. A stock market index is a statistical tool that measures the trends in the stock market by observing the price movement of a collection of stocks that fairly represent the overall stock market.
When the stock prices of a large portion of companies under the stock market index crash together, the phenomenon is called a stock market crash. Some financial experts also define a stock market as a condition when a majority of companies on stock market indices lose their value in double-digit percentages in a very short period of time. In the US, popular stock market indices include the S&P 500 and the DJIA. Meanwhile, Sensex and Nifty are the stock market indices that are primarily used in India. Stock market crashes can be scary as they can signify economic instability. Moreover, investors lose a ton of net worth and some companies may also decide to lay off employees to save on costs.
As mentioned, the stock prices of major companies experience a sharp drop when a stock market crash happens. At its core, a stock market crash happens when people lose confidence in these publicly traded companies and sell off their stocks to convert their investments into cash or cash equivalents. Sometimes the effects of a stock market crash can last for a short time, from a few months to just a couple of years. However, in case of stock market crashes that are extremely severe, it may take a very long time for the stock market to get back to the pre-crash conditions. For instance, during the stock market crash of October 1929 in the United States, the stock market lost approximately 85 per cent of its overall value. This stock market crash was also a contributing factor to the ‘Great Depression’. The stock market only started recovering slowly after over a decade. So what causes these stock market crashes?
There are multiple factors that can lead to a stock market crash. Stock market crashes generally happen after a period of sustained economic growth when confidence in the economy and the market conditions is extremely high. Here are some of the major reasons behind stock market crashes:
Natural disasters like floods, droughts, pandemics, etc, can cause an immense amount of damage to the economy, crippling the manufacturing capabilities of various companies. As the flow of money dries up, consumers also look to save money and demand for non-essential goods slows to a halt. All of these factors combined often lead to a stock market crash. For instance, the Covid-19 pandemic caused a major stock market crash in 2020 that lasted from the end of February to April.
A major economic crisis in a single sector of the economy can often have a ripple effect, and negatively affect the stock prices of major companies on the stock market. For instance, during the US housing crisis of 2008, the whole stock market suffered a major crash. While the economic crisis was initially only limited to the housing sector, the ripple effect it had affected all of the US economy, as well as the economies of many countries around the world.
When people start investing in a particular sector or industry based on the speculation that it will continue to grow, it creates a kind of bubble effect where these companies become extremely overvalued beyond their real worth. When the performance and returns from these companies are not as per the expectations of the investors, the bubble bursts as the investors rush to pull out their investments. This phenomenon leads to economic instability ultimately resulting in a stock market crash. Case in point, when the dot com bubble burst in 2001, it lead to a major stock market crash.