A stock market or equity market is a
public entity for the trading of company stock or shares and derivatives at an
agreed price; these are securities listed on a stock exchange as well as those
only traded privately. There are many stock markets around the world, prominent
among them are: United States (US) New York Stock Exchange (NYSE), US American
Stock Exchange (AMEX), US National Association of Securities Dealers Automated
Quotation (NASDAQ), Germany -Börse Frankfurt, United Kingdom - London Stock
Exchange, Australia ASX, Shanghai SE Composite Index of China, Hang Seng Hong
Kong, Mumbai Sensex India, Nikkei 225 Japan, Taiwan TSEC 50 Index and so on.
A stock market crash is a sudden
dramatic decline of stock prices across a significant cross-section of a stock
market, resulting in a significant loss of paper wealth. Crashes are driven by
panic as much as by underlying economic factors. They often follow speculative
stock market bubbles. Also, Stock market crashes are social phenomena where external
economic events combine with crowd behavior and psychology in a positive
feedback loop where selling by some market participants drives more market
participants to sell (Burton, 2006). There are several stock market crashes
since the inception of stock markets but, the major ones are: the crashes in 1929, 1987, 1997, 2001, and
2007.
In October 29, 1929, the Dow Jones
Industrial Average fell more than 11 percent on "Black Tuesday", with
a record volume of 16 million shares traded. It heralded the beginning of the
"Great Depression" of the 1930s. It did not surpass the 1929 average
again until 1954 (Narayana, 2008).
News of a big U.S. monthly trade
deficit on October 14 sparked the crash of 1987. The Dow took the first
100-point dive in its history on October 16, 1987 and again on October 19,
"Black Monday". Wall Street lost 508.32 points taking the Dow down to
1,738.4. The crash wiped 22.6 percent off the value of the New York Stock
Exchange, compared with 12.8 percent on the worst day of the 1929 Wall Street Crash
(Narayana, 2008).
The crash of 1997 was emanated from financial
turmoil in Asia that began in July when international currency speculators bet
against the Thai baht helped trigger the biggest single-day point decline in
the Dow Jones industrial average on Monday, October 27, 1997. Stock markets in
Argentina, Mexico, and Brazil dropped between 13 and 15 percent. It spilled
over into European markets on October 28. Tokyo's Nikkei 225 index fell 725.67
points or 4.26 percent to 16,312.69. Singapore's Straits Times Index ended
122.87 or 7.59 percent lower to 1,497.03(Narayana, 2008).
The crash of 2001 is another global
stock crash was triggered by the September 11, attack on the United States.
Investors across the world snapped up traditional safe assets like gold and
bonds after the attack pummeled global stocks, shook the U.S. dollar and drove
up oil prices. Main U.S. markets were closed after the attacks, which occurred
just as the trading day was about to begin. After a delayed opening, Tokyo stocks
slid to 17-year lows, with the Nikkei stock average losing 6.23 percent to
9,651.62 and breaching 10,000 for the first time since August 1984. European
stock indices fell to their lowest levels since December 1998. London's FTSE
100 index shed 5.7 percent in its biggest one-day fall since the crash of
October 1987, wiping $98 billion off the value of shares (Narayana, 2008).
On February 27, 2007, the Dow index fell 3.3
percent, or 416 points, following a collapse in Chinese stocks and weak U.S.
manufacturing data. The Nikkei share average lost more than 3 percent and the
FTSE 100 was down 116.1 points, or 1.85 percent. Mexican stocks lost 4 percent
and Chinese stocks plunged nearly 9 percent, erasing about $140 billion of
value in their biggest fall for a decade (Narayana, 2008)
The crash of 1929: Over the years market crashes have drove away many investors from stock
trading. Starting with the 1929 stock market crashed once the First World War
was over, the U.S. entered into a new era. It was a time of great enthusiasm,
and optimism. This was a time when great inventions, like the airplane and
radio, made pretty much anything seem possible in the 1920′s.
By around 1925, more and more people were
getting involved in the stock market. Then in 1927, there was a very strong
upward price trend. This enticed even more people to get into the stock market.
By 1928, the stock market boom had taken off.
At this point, the stock market seemed like a
place where virtually everyone thought they could become rich. The stock market
had reached a fever pitch. Everyone thought they were an expert, and stocks
were talked about everywhere. Tips were given by almost everyone. Lesson number
one: Beware when the fever pitch is high, and everyone thinks they are a master
of the stock market, getting richer by the day. Beware when everything seems
too good to be true, and tips are given out by almost everyone (Rosenberg
2011).
About this time, the Federal Reserve
began to raise interest rates. Then in March of 1929, the stock market suffered
a mini crash. In the spring of 1929, there were more signs that the economy
could be headed for trouble. Steel production went down, house construction
slowed down, and car sales tailed off. Lesson number two: Rising interest rates
is a negative for the stock market. Also, when economic conditions begin to
deteriorate, this is another negative (Kerkow, 2010).
In the summer of 1929, the market surged ahead
again, and all early warning signs were forgotten. From June through August,
the stock market reached its highest price level ever. Nearly everyone thought
it was a stock market heaven, which would never end. Lesson number three: When
the market seems too good to be true, it probably is, and at the very least, a
correction is coming soon (Kerkow, 2010).
It is important to remember that markets do
not go straight up forever. What we are seeing here is a classic example of mob
psychology in full force. This is human nature at work, with the emotion of
greed taking over many people.
By August of 1929, many leading stocks were
rising in price in dramatic fashion. This is called a climax run, and another
warning sign of trouble up ahead for the market. Lesson number four: When
leading stocks, after a big run up in price, make huge price gains in a
relatively short period of time, this is a warning sign of the market topping(Kerkow,
2010)..
The stock market peaked in September
of 1929. At this point, heavy selling in big volume began to happen, and became
somewhat common place. This is a major sign that smart money was leaving the
market. There were five declines on heavy volume throughout September. All this
selling was happening a full month before all hell broke loose in the stock
market. Lesson number five: When general market declines on heavy volume begin
to mount, it is definitely time to start selling your stocks. This is a major
warning sign (Kerkow, 2010).
The Dow declined nearly 90% from its peak in September,
1929, to its July, 1932 bottom. Many people lost their entire savings, and
more. Savvy traders saw many signs of trouble, and had plenty of time to exit
the market, before it really started to crash. Lesson number six: Those who
knew the market warning signs, and acted, had plenty of time to exit the
market, before it crashed, late in 1929. These stock market warning signs are
just as valid today, as they were back then. Always keep an eye out for these
warning signs, and act appropriately (Rosenberg 2011).
The crash of 1987: In the days between October 14 and October 19, 1987, major indexes of
market valuation in the United States dropped 30 percent or more. On October
19, 1987, a date that subsequently became known as “Black Monday," the Dow
Jones Industrial Average plummeted 508 points, losing 22.6% of its total value,
The S&P 500 dropped 20.4%, falling from 282.7 to 225.06. This was the
greatest loss Wall Street had ever suffered on a single day.
According to Facts on File, an
authoritative source of current-events information for professional research
and education, the 1987 crash “marked the end of a five-year 'bull' market that
had seen the Dow rise from 776 points in August 1982 to a high of 2,722.42
points in August 1987." Unlike what happened in 1929, however, the market
rallied immediately after the crash, posting a record one-day gain of 102.27
the very next day and 186.64 points on Thursday October 22. It took only two
years for the Dow to recover completely; by September of 1989, the market had
regained all of the value it had lost in the '87 crash (Itskevich 2002).
Many feared that the crash would
trigger a recession. Instead, the fallout from the crash turned out to be
surprisingly small. This phenomenon was due, in part, to the intervention of
the Federal Reserve. According to Facts on File, “The worst economic losses
occurred on Wall Street itself, where 15,000 jobs were lost in the financial
industry (Itskevich,
2002).”
A number of explanations have been
offered as to the cause of the crash, although none may be said to have been
the sole determinant. Among these are computer trading and derivative
securities, lack of liquidity, trade and budget deficits, and overvaluation.
What the 1987 crash ultimately
accomplished was to teach politicians that markets heed their words and actions
carefully, reacting immediately when threatened. Thus the crash initiated a new
era of market discipline on bad economic policy. It also teaches investors that
investing is a long-term processes not a one off transaction. At that time
investors wouldn’t be able to sell their stocks when they wanted to sell their
stocks, the market would over-correct, go down too far, and then bounce back
later. To add more, as Warren Buffet ones said “invest in companies not
market.”
The crash of 1997: The October 27, 1997 market crashed was called the mini-crash that was caused
by an economic crisis in Asia. At that time, the Dow Jones Industrial Average
plummets 554.26 points to 7,161.15. For the first time, the New York Stock
Exchange activated their “circuit breakers” twice during the day eventually
making the controversial move of closing the exchange early. Also, the NASDAQ
lost 115.58 points (abcnews.com, 2011).
Investors may have realized Japan was
becoming a bubble, but it was believed that the high level of collusion between
the government and business could sustain the growth forever. But an inverted
growth cycle perpetuated itself when landowning firms started using the book
value of their land to buy stocks that they in turn used to finance the
purchase of American assets (Rockefeller Center is 80% owned by Mitsubishi
Estate Company). Like the prosperity of the Roman Empire, the prosperity of
Japan proved to be its undoing as corruption began to spread throughout the
political and business realms(investopedia.com, 2011)..
The bursting of the Asian bubble
nearly took out the American economy as well, but the measures enacted after
1987 sopped the avalanche of program trading. We learned at least one lesson from
all of these crashes: humans may overact frequently with small effects, but
computers do it only once in a big way.
The crash of 2001: Following the
worst terrorist attack in U.S. history on Sept. 11, the market plummeted on its
first day of trading, the American Stock Exchange and New York Stock Exchange
having been shut down for almost a week. The value of two present-day titans of
banking and investments, JPMorgan Chase and Citigroup, dropped 6% by midday
(Altman and Romero, 2011).
The lessons learned here, are
our resilience to handle unexpected events. Also, it is impossible to consistently
guess the highs and lows of the stock market so don't even try. Instead, keep
investing regular amounts in both bulls and bear markets. You need to be in the
stock market over long time periods to reap its rewards. It increases investors
CD mentality." In other words, investors must expect to lose principal
sometimes or to see a loss or reduction in earnings. Investments are inherently
volatile and unpredictable in the short-term. More so, a loss is a loss only if
you sell. The lessons of
history will be enormously helpful at such a time to provide a reality check on
our emotional urge to dump all risky assets and go to cash.
Again, emerging markets hold
potential to inject back into North American market. Markets are more global
and connected than in 1987 and 1997. Now, no market is immune to significant
local event. Since 1987 and 1997 banks have become more experienced at handling
global market crisis.
The crash of 2007: In October 2007 marked another great recession since the 1929
depression. The Standard and Poor (S&P) 500 declined 57% from its high in
October 2007 of 1576 to its low in March 2009 of 676; many indicators of credit
risk such as the "Ted Spread" or the option adjusted spread (OAS) on
corporate bonds reached record highs (investopedia.com, 2011).
Following the bursting of the tech
bubble and the recession of the early 2000s, the Federal Reserve kept
short-term interest rates low for an extended period of time. This coincided
with a global savings glut, as developing countries and commodity producing
nation’s accumulated large financial reserves. As these excess savings were
invested, global interest rates declined to record low levels. Frustrated with
low returns, investors began to assume more risk by seeking higher returns
wherever they could be found. For several years, global financial markets
entered a period which came to be called the "Great Moderation" due
to the above-average returns and below-average volatility demonstrated by a
wide variety of asset classes (Beatie, 2011).
In the United States, the Great
Moderation coincided with a housing boom, as prices soared (particularly on the
two coasts and in cities such as Phoenix and Las Vegas.) Rising home prices led
to rampant real estate speculation, and also fueled excessive consumer spending
as people began to view their homes as a "piggy bank" that they could
extract cash from to fuel discretionary purchases. As home prices soared and
many homeowners "stretched" to make their mortgage payments, the
possibility of a collapse grew. However, the true extent of the danger was
hidden because so many mortgages had been securitized and turned into AAA-rated
securities (investopedia.com, 2011).
When the long held belief that home
prices do not decline turned out to be inaccurate, prices on mortgage-backed
securities plunged, prompting large losses for banks and other financial
institutions. These losses soon spread to other asset classes, fueling a crisis
of confidence in the health of many of the world’s largest banks. Events
reached their climax with the bankruptcy of Lehman Brothers in September 2008,
which resulted in a credit freeze that brought the global financial system to
the brink of complete collapse.
Unprecedented central bank actions
combined with fiscal stimulus (notably in the US and China) helped ease some of
the panic in the market place, but by late winter 2009, widespread rumors
surfaced that Citigroup (NYSE:C), Bank of America (NYSE:BAC), and other large
banks would have to be nationalized if the global economy was to survive.
Fortunately, the aggressive actions by governments around the world eventually
helped avoid financial collapse, but the credit freeze forced the global
economy into the worst recession since World War two (investopedia.com, 2011).
The credit crisis and accompanying
recession caused unprecedented volatility in financial markets. Stocks fell 50%
or more from their highs through March 2009 before rallying more than 50% once
the crisis began to ease. In addition to stocks, most fixed income markets also
displayed unprecedented volatility, with many corporate bond markets at one
point forecasting bankruptcies at a level not seen since the Great Depression.
Oil fell 70%, then doubled as the financial system stabilized (Beatie, 2011).
The events of the housing bubble and
credit crisis are likely to resonate with consumers and investors for years to
come. In many countries (including the U.S.) consumers remain heavily leveraged
and many homeowners are "underwater." As consumers deleverage and
repair their finances, their purchasing patterns will be permanently altered.
Many developed market countries have also seen a substantial deterioration in
their fiscal position. While government actions helped prevent worst-case
outcomes from the credit crisis, large budget deficits now represent a
structural problem that may take decades to solve (Investopedia.com, 2011).
Finally, the lessons learned so far
from this crash is that investors have experienced the most volatile and
frightening markets of their life. Positive lessons, such as the importance of
diversification and independent analysis can be taken from the crisis, but
there are also emotional affects that must be considered. In particular,
investors must remember that the events of the crisis were unusual and are
unlikely to be repeated; while excessive greed in the financial markets is
inappropriate, so too is excessive fear. Investors that can incorporate the
lessons of the credit crisis without having their emotions unduly influenced will
be best positioned for future investment success.
Conclusion: Sudden
stock markets crash leads to confusion and chaos and the stockholders start selling
stocks at a random rate. Psychology of the shareholders changes and a massive
change in the crowd behavior become prominent during a market crash .A stock
market boom can come to an end with a market crash. So, it is prudent to keep
an eye on the market trends First off, we should point out that most market
volatility is our entire fault. In reality, people create most of the risk in
the market place by inflating stock prices beyond the value of the underlying
company. When stocks are flying through the stratosphere like rockets, it is
usually a sign of a bubble. That's not to say that stocks cannot legitimately
enjoy a huge leap in value, but this leap should be justified by the prospects
of the underlying companies, not just by a mass of investors following each
other. The unreasonable belief in the possibility of getting rich quick is the
primary reason people get burned by market crashes. Remember that if you put
your money into investments that have a high potential for returns, you must
also be willing to bear a high chance of losing it all. Another observation we
should make is that regardless of our measures to correct the problems, the
time between crashes has decreased. We had centuries between fiascoes, then
decades, then years. We cannot say whether this foretells anything dire for the
future, but the best thing you can do is keep yourself educated, informed, and
well-practiced in doing research. To crown it all, the Security and Exchange
Commission (SEC), Congress, and any other concern entities should be proactive
rather than reactive in dealing with issues in order to prevent future market
crash.
References:
Altman, A & Romero, F. (2011). Top
10 Dow Jones Drops. Retrieved on May 1, 2011 from: http://www.time.com
Beattie, A. (2010). Market Crashes: Housing Bubble and
Credit Crisis. Retrieved on April 28 from: http://www.investopedia.com
Burton, M. G. (1973). A Random Walk
Down Wall Street (6th ed.). W.W. Norton & Company, Inc. United States.
Itskevich, J. (2002). What Caused the
Stock Market Crash of 1987? Retrieved on April 29, 2001 from: http://hnn.us/articles/
Kerkow, G.E. (2010) Lessons Learned- The 1929 Stock
Market Crash
Narayana, (2008).Fact box: major
stock market crashes. Retrieved April 27, 2011 from http://www.reuters.com/article/2008/01/21/us-market-crashes
Ram, A. (2011).Global Stock Market
Crash. Retrieved on April 30, 2011 from: http://abcnews.go.com/Archives/video/
Rosenberg, J. (2011). The Stock Market Crash of 1929.
Retrieved on May 1, 2011 from: About.com Guide
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