A:

The stock market crash of 1929 was due to a market that was overbought, overvalued, and excessively bullish, rising even as economic conditions were not supporting the advance. The crash began on Oct. 24, 1929, when the market opened 11% lower. Institutions and financiers stepped in with bids above the market price to stem the panic, and the losses on that day were modest with stocks bouncing back the next two days. However, this bounce turned out to be illusory, as the following Monday, now known as Black Monday, the market finished down 13% with the losses exacerbated by margin calls. The next day (Black Tuesday), bids completely vanished, and the market fell another 12%. From there, the market trended lower until hitting bottom in 1932.

Before this crash, the stock market peaked on Sept. 3 with the Dow Jones Industrial Average (DJIA) at 381.17. The ultimate bottom was reached on July 8, 1932, where the Dow stood at 41.22. From peak to trough, this was a loss of 89.19%. The price of blue chip stocks declined, but there was more pain in small-cap and speculative stocks, many of which declared bankruptcy and were delisted from the market. It was not until Nov. 23, 1954 that the Dow reached its previous peak of 381.17. (For more, see An Introduction to the Dow Jones Industrial Average.)

The stock market crash of 1929 and the ensuing Great Depression altered an entire generation's perspective and relationship to the financial markets. In a sense, it was a total reversal of the attitude of the Roaring '20s, which had been a time of great optimism and economic growth.

A Period of Phenomenal Growth

In the first half of the 1920s, companies were doing excellent business exporting to Europe, which was rebuilding from the war. Unemployment was low, and automobiles were spreading across the country, creating jobs and efficiencies for the economy. Until the peak in 1929, stock prices went up by nearly 10 times.

The economic growth created an environment in which speculating in stocks became almost a hobby, with the general population wanting a piece of the market. Many were buying stocks on margin -- the practice of buying an asset where the buyer pays only a percentage of the asset's value and borrows the rest from the bank or a broker -- in ratios as high as 1:3, meaning they were putting down $1 of capital for every $3 of stock they purchased. This also meant that a loss of one-third of the value in the stock would wipe them out.

People were not buying stocks on fundamentals; they were buying in anticipation of rising share prices. Rising share prices simply brought more people into the markets, convinced that it was easy money. In mid-1929, the economy stumbled due to excess production in many industries, creating an oversupply. Essentially, companies were able to acquire money cheaply due to high share prices and invest in their own production with the requisite optimism.

This overproduction eventually led to oversupply in many areas of the market such as farm crops, steel, and iron. Companies were forced to dump their products at a loss, and share prices began to falter. Due to the number of shares bought on margin by the general public and the lack of cash on the sidelines, entire portfolios were liquidated and the stock market spiraled downwards.

Read all about trading on margin here - Margin Trading. You can also read more about crashes that affected the economy in the guide The Greatest Market Crashes.

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