What Is a Stock Market Crash?
A stock market crash is a rapid and often unanticipated drop in stock prices. A stock market crash can be a side effect of a major catastrophic event, economic crisis or the collapse of a long-term speculative bubble. Reactionary public panic about a stock market crash can also be a major contributor to it.
Understanding Stock Market Crashes
Although there is no specific threshold for stock market crashes, they are generally considered as abrupt double-digit percentage drop in a stock index over the course of a few days.
Well-known U.S. stock market crashes include the market crash of 1929, which resulted from economic decline and panic selling and sparked the Great Depression, and Black Monday (1987), which was also largely caused by investor panic.
Another major crash occurred in 2008 in the housing and real estate market and resulted in what we now refer to as the Great Recession. High-frequency trading was determined to be a cause of the flash crash that occurred in May 2010 and wiped off trillions of dollars from stock prices.
In March 2020, stock markets around the world declined into bear market territory because of the emergence of a pandemic of the COVID-19 coronavirus.
- Stock market crashes are an abrupt double-digit drop in stock prices.
- Several measures have been put in place to prevent stock market crashes. Examples of these measures include circuit breakers and trading curbs to lessen the effect of an abrupt drop in prices.
Preventing a Stock Market Crash
Since the crashes of 1929 and 1987, safeguards have been put in place to prevent crashes due to panicked stockholders selling their assets. Such safeguards include trading curbs, or circuit breakers, which prevent any trade activity whatsoever for a certain period of time following a sharp decline in stock prices, in hopes of stabilizing the market and preventing it from falling further.
For example, the New York Stock Exchange (NYSE) has a set of thresholds in place to guard against crashes. They provide for trading halts in all equities and options markets during a severe market decline as measured by a single-day decline in the S&P 500 Index. According to the NYSE:
- A market-wide trading halt can be triggered if the S&P 500 Index declines in price as compared to the prior day’s closing price of that index.
- The triggers have been set by the markets at three circuit breaker thresholds—7% (Level 1), 13% (Level 2), and 20% (Level 3).
- A market decline that triggers a Level 1 or Level 2 circuit breaker after 9:30 a.m. ET and before 3:25 p.m. ET will halt market-wide trading for 15 minutes, while a similar market decline at or after 3:25 p.m. ET will not halt market-wide trading.
- A market decline that triggers a Level 3 circuit breaker, at any time during the trading day, will halt market-wide trading for the remainder of the trading day.
Markets can also be stabilized by large entities purchasing massive quantities of stocks, essentially setting an example for individual traders and curbing panic selling. However, these methods are not only unproven, they may not be effective. In one famous example, the Panic of 1907, a 50 percent drop in stocks in New York set off a financial panic that threatened to bring down the financial system. J. P. Morgan, the famous financier and investor, convinced New York bankers to step in and use their personal and institutional capital to shore up markets.
Stock market crashes wipe out equity-investment values and are most harmful to those who rely on investment returns for retirement. Although the collapse of equity prices can occur over a day or a year, crashes are often followed by a recession or depression.
For a detailed lesson on market crashes and a history lesson on the most famous crashes from around the world, read The Greatest Market Crashes.