Last Updated on October 4, 2023 by BFSLTeam BFSLTeam
If there’s one thing every trader, investor and company fears, more than anything else, it’s a stock market crash. The crash can be a nightmarish scenario and is probably one of the first things every realistic or pessimistic trader may think of when they put a lot of their money into the market. You too may have feared the worst if you took large positions in any stock or derivative.
However, not every drop in price is a market crash. Sometimes, it’s just a bearish market that will soon be reversed. So, what is the true meaning of a stock market crash and why does it occur? Let’s find out all these details and more in this article.
Also Read: Leverage in Stock Market
Table of Content
What is a Stock Market Crash?
A sudden, severe and unanticipated fall in the price of shares across all sectors and companies is described or referred to as a crash. This sudden fall in the share prices is usually drastically and could be as high as 20 percent. The crash lasts for a brief period before the market stabilizes itself.
The stock market crash can have severe consequences for the investors and also leave a lasting impact on the companies as well as the overall.
What Causes a Stock Market Crash?
Now that you’ve seen the definition of a stock market crash, let’s look at some of the factors that contribute to it.
- Speculative Bubbles
A positive market sentiment, hype, or flavour, can sometimes drive a sharp rise in stock price which creates a speculative bubble. This rise is majorly not based on any rationale and may reverse as shockingly as it began.
Stocks are considered overvalued if their price is significantly higher than their intrinsic value. These bubbles are usually formed due to excessive speculation and bullish investor sentiment. When these bubbles burst, the stock prices plummet drastically within a short period, leading to a stock market crash.
- Economic Downturns
Prolonged periods of inflation and economic recessions lead to reduced consumer spending, lowering the revenue and profits for companies. Such situations generally lower investor confidence and may trigger a stock market crash.
- Tax and Monetary Policy Changes
Any change in the monetary policy has its effect on the stock market. A dramatic and radical policy change can cause havoc in the market as it can alter the way businesses have been happening.
- Geopolitical Instability
Major changes in the geopolitical scenario can also cause panic selling among investors leading to a stock market crash. Wars, political instability, tensions between countries and trade restrictions are a few events that can upend the markets.
A History of Stock Market Crashes in India
The stock market in India has remained largely resilient in wake of the global changes and upheavals. However, there have been several market crashes that have left the market and the economy shocked.
As an investor, it is important that you know about these stock market crashes as it can help you stay better prepared.
- The Stock Market Crash of 1992
A crash fueled by a major scam by Harshad Mehta, who was considered the Big Bull of the Indian stock market. In 1992, Harshad Mehta artificially pumped up the demand for the stock of ACC Limited by purchasing its shares. This took the stock price from ₹200 to ₹9,000 in just a few months. He even borrowed crores of Rupees from various banks to fund its buying spree. It was an unprecedented stock market crash as the Sensex fell by around 2,000 points.
- The Financial Crisis of 2008
In 2008, Sensez fell 1408 points in one day as a global financial crisis caused ripples across world markets. The crisis was triggered by the U.S. subprime lending crisis and eventually caused the bankruptcy of Lehman Brothers. The markets took more than 2 years to recover from this stock market crash.
- The COVID-19 Pandemic of 2020
The nationwide lockdown imposed to curb the spread of COVID-19 led to another unprecedented stock market crash in India. In just a week, Sensex dropped by around 13,985 points, making it one of the biggest crashes the market has witnessed in recent times.
Can Stock Market Crashes be Prevented?
It is one of the most difficult things, if not outrightly impossible, to prevent a stock market crash. What makes the prevention difficult is the sheer suddenness and speed of the crash, both of which can take everyone by surprise and shock.
However, there are a few measures that can help reduce the severity of a stock market crash and help the market to limit the long-term impact and make fast recovery.
- Strong regulatory frameworks and oversight to ensure financial markets operate fairly and transparently
- Extensive risk management measures by both the listed companies, stock exchanges, stockbrokers and financial institutions
- Implementation of sound monetary policies by central banks to reduce or mitigate economic downturns or recessions
- Diversification of investment portfolio by investing in multiple sectors and asset classes to reduce risk exposure
Also Read: Portfolio Diversification
Conclusion
This sums up the definition of a stock market crash, the fundamentals of what triggers such a crash and some crashes the Indian market has witnessed over the years. While it is natural to be scared of market crashes, panic selling can become a costly mistake if you worry each time the share price drops even a little bit.
The best way to continue to participate in the markets despite the threat of potential market crashes is to diversify your portfolio among different asset classes, set stop losses for your orders and keep yourself updated about the developments in India and across the world — particularly with respect to the stocks you hold and the industries they belong to.
