What Is A Stock Market Crash? When Do Market Crashes Happen And How To Predict Them?

A stock market crash is a sharp and unexpected decline of stock market prices for a very short period of time, usually accompanied by the decline of many other assets’ prices. As a result, the most of the investors and speculators in the market realize significant capital losses. The losses themselves cause panic and fear among market participants, this deepens the contraction and causes more losses, they cause more panic, etc. This way a stock market crash is usually a self-reinforcing process that is totally uncontrollable.

The crash of the Dow Jones index in 2007

The crash of the Dow Jones index in 2007

Stock market crashes are social events caused by both, economic conditions and human behavior. Usually, a crash happens when economic participants have far from reality perceptions and assessment of the situation, which usually cause stock market bubbles. It is not that easy to define the “far from reality” situation, though. There are no clear, objective and specific reasons for crashes and that’s why they are hardly predictable. But when they happen, they are clearly recognizable by a sharp and steep decline of market prices for a very short period of time caused by panic and fear.

Market crashes are not only harmful to stock market participants, but they also affect the whole society causing economic crises. Usually, a crash is followed by a depression or a recession, which cause higher unemployment, bankruptcies, bank failures, falling prices and lower living standards.

Crashes and crises are the big flaws of capitalism. Even the modern economic science is not able to stop and fully explain economic crises. This raises some serious questions about the degree to which the theories are applicable to the real world. According to free market theory (the backbone of modern capitalism), the market has to correct itself automatically, if it is not in equilibrium. This way a crisis would be avoided, but this doesn’t seem to work in reality. Not only the market doesn’t correct itself, but also the contraction could self-reinforce itself. This is what has been happening for the last several years since the mortgage crisis began in 2007. A proof for this is also many other economic crashes happening every several years.

A major conception explaining stock market crashes and economic crises is George Soros’ Reflexivity theory, which I find the most relevant one. I am highly influenced by his work and will try to explain some of the major crashes using Soros’ arsenal of knowledge. Read more about this great investor here, and about his Reflexivity theory here.

Stock market crashes have very common features and at the same time, there are many differences between them. Here in this site, I will analyze some of the major ones and will try to find the similarities and differences between them. Crashes could happen not only in stock markets but in any free market, including real estate market, commodities market and any other. A great example for this is the tulip mania, which turned into a great crash in tulip pulps’ market prices, wiping out many people’s fortunes. It really doesn’t matter what the market is, all market crashes are similar to each other. Every one of them is caused by super optimism, irrational behavior, greed, and fear.