How Does a Stock Market Crash Occur? Understanding the Basics

There’s no doubt that a struggling economy takes its toll on everyone. Although we may not be at our lowest point now, many of us are still feeling the effects of an unstable economy. At the moment, the stock market seems to be moving full steam ahead, but history has shown us times when the market has crashed, leading to devastating losses both on a personal and national level. But how exactly does a stock market crash occur?

To understand this, we first need to define what a stock market crash is. Interestingly, there is no specific definition that all economists agree upon. However, the general consensus is that a crash is when the market experiences a double-digit percentage loss in only a few days, rather than the gradual decline seen over months or years in a bear market.

Many people assume that a crash is always triggered by significant events. While there is some truth to this, as major events can certainly be a factor, it isn’t always the case. There are plenty of instances where negative events didn’t result in a crash, suggesting that something more is at play.

The main driving factor in most stock market crashes is panic. This panic might be partially fueled by some actual event, but more often, it lacks a logical basis. It begins when a few investors become skittish and decide to sell large portions of their stock at a reduced price. Seeing this, other investors start selling as well, assuming there must be a significant reason for the sudden sell-off. Once this fear reaches mainstream investors, a crash can quickly follow.

In essence, the phenomenon isn’t driven by logic but by an economic domino effect. For example, consider a minor conflict in a Middle Eastern country that supplies a large portion of the world’s oil. A few investors might panic and sell off their stocks, fearing future losses. They think they are making an educated decision, though there’s no way to predict how any particular stock will respond to the event.

Then, as word of this initial sell-off spreads, more investors follow suit, perceiving a major issue even when there may not be one. This chain reaction is essentially how a stock market crash occurs—panic snowballs, spreading quickly through the investor community until it impacts the entire market.