What causes the stock market to crash?

Question

What exactly does the term "crash" mean? Is it when the price of the shares go down too low? And how do they determine the price of the shares?

I still don't understand one thing...so if people are trying to pull out of the stock market, does that mean they are selling back to the company or to everyone? I mean if no one will buy the stocks, would the company have to buy it back?

Answer 1

The last two stock market crashes (1929 and 1987) both had a one day 25% drop in value. This happens when there is a panic and people try to sell quickly to get out before everyone else. The two crashes were very different -- but here is, basically, what happened.

In the 1929 crash, people were allowed to buy up to ten times on margin. That means that for a $100 investment, you could buy $1,000 worth of stock. For a $10,000 investment, you could buy $100,000 worth of stock. The investment bank loaned you the extra money. They kept the shares in house to act as collateral. If the price of the stock went down, they asked you to deposit more money or sell some shares to keep your margin account current.

That means that if your stock goes up 10%, you can double your money. It also means that if the stock drops a lot, you not only lose your investment -- you owe a lot of money. In the late 1920s, people didn't care -- because the stock market went up. Instead of taking out their money -- a lot of people reinvested it & then bought more shares on margin. When a minor correction came, people lost a lot instead of a little. They had to sell shares to cover the margin calls. Selling these shares pushed down the price further -- causing them to take new losses & having to sell more to cover the margin calls again. Eventually, the market crashed because of all the selling, and lots of people went bankrupt.

The 1987 crash was very different. Stocks kept going up in the 1980s -- just like in the 1920s. But margins were cut to two times -- so the market wouldn't have the same kind of credit problems. By this time, the market was controlled by institutional traders (like mutual funds). A lot of these funds were using a Program Trading technique called "Portfolio Insurance" that was developed by two Berkeley professors -- Mark Rubinstein and Hayne Leleand. The basic idea of this trading strategy was to mimic the payoff of a call option. If the market goes up, it involved buying more shares. If it went down, it involved selling shares. As long as volatility stays low -- this strategy works great. But if there is a sudden drop in the market, the programs that controlled the buys & sells would tell the funds to sell. They did -- but since so many people were using the technique, there were so many people selling, that it moved the market downwards. This, in turn, caused the programs to tell the traders to sell more. Pretty soon, everyone was panicking & sold shares into the market -- causing it to crash.

To answer your last question about who would buy -- there is always someone who will buy stock if the price is low enough. But there are marketmakers for stock. These are people who have the job of making an orderly market for each stock. They usually hmatch up buyers with sellers (and take a fee for brokering the deal). But they are willing to sell from their own inventory or buy from people if it is to their advantage to do so -- or if no one else is there. On the NYSE, these people are called Specialists. Several Specialist firms went out of business in the 1987 crash -- because they were forced to buy when no one else wanted to.

Answer 2

The price is determined by supply and demand.

Tipically some buy and some sell.

If the number of shares sold is the same as the number of shares bought then the price stays the same (This case is almost impossible)

In a crash EVERYBODY IS SELLING.

They are selling to everybody.

If nobody is buying at $9.00 then the price is lowered to $8.99 and if nobody is buying then the price is lowered to $8.98 and so on.

In theory the stock could go down all the way to $0.01 just like in the film "Fun with Dick and Jane" starring Jim Carrey.

Obviously this case is almost impossible.

At some point somebody smart would realize the company is worth something (They have land, cars, merchandise in the stores and obviously money in the bank) and he would buy every stock he can afford.

Smart investors are always monitoring the book value of stocks and if the stock is too low they buy as much as they can.

Warren Buffet Jr. (Second richest man alive) used to buy stocks with a P/E of 1 when he was young.

Answer 3

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Answer 4

Think of it this way: The stock market is an auction. There are sellers who "ask" and buyers who "bid". When the market crashes, it is because the merchandise (stock) is seen to be devalued in some way (more on that later), and that makes the sellers more willing to lower their ask price so they can unload it (they don't want to be left holding the undervalued merchandise) and the buyers "bid down" the stock by offering to buy at lower and lower prices in the hopes of getting a bargain.
The price per share is determined by the most recent trade. On the open market there will be a "spread" between the bid and the ask. A trade occurs when a seller willingly takes the bid or a buyer willingly takes the ask.

There are many factors involved in how to value stocks and how stock value is perceived. Some of the answers you have already talk about some of them.

Hope this helps!

Answer 5

the price of the shares are determined by the demand for the shares. If companies are doing well and their financial statements show better than expected results, then more people will want to buy those company's shares so the demand goes up, which causes the price to rise. If the economy is doing bad and the companies are under performing then nobody wants to buy the shares and they become worthless and the stock market has "crashed". Thats pretty much it in a nutshell, I dont know all the details but im a econ major so this should be pretty accurate :)!

Answer 6

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Answer 7

When everyone attempts to sell their shares of stock before the price/value thereof bottoms out and they are stuck with a loss.
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When there are only sellers and no buyers, that is what constitutes the crash. The price per share plummets and the stock becomes valueless. Result: The company incorporated with the stock sees its value plummet as well.

Remember, there are two main ways to fund a corporation: Stock subscriptions and bond issuance. Bonds are debts to be repaid. Stocks are ownership in a company. If the value of your share equals zero, the company is essentially worthless as the stock representing it.
Stock values are fixed artificially in the beginning based upon the value of company assets prorated over the number of shares to be issued.

Usually there is someone out there who has the money to buy stock as its value goes down. As long as there is a buyer, there is a market. If there occurs a situation where there is no buyer for any stock as the value of all stocks declines, the market is glutted with shares for sale. The company itself will buy the stock PROVIDED it has the $$$. If it doesn't, the seller is screwed.

Answer 8

Stock market crash occurs when most people in the stock market decided to sell their stocks within a relatively short period of time and there are far less stock buyers in the market to absorb the sale.In this case we have supplies far exceeded demand and most of the stock values become exceedlingly low.Just like if everyone throwing out junks at once hence crash occur.

Answer 9

Back in the day when the market crash it was do to over working a good thing and no fell safe plan. Now today it will go into the red because greed, but there is a fell safe plan that is suppose to prevent this crashing from happening

Answer 10

It means people are pulling out of the stock market because of fears of losing their investments. To attract more investors to come back in, stock prices become low.

What causes this? Oil prices, war, terrorism, big natural storms like hurricanes, inflation, federal reserve increasing interest rates, but mostly by major big events you see on the news.