How does a market ‘crash’?
In: Economics
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Unpredicted economic catastrophe; 2008
Over enthusiastic expectations that don’t happen: 1999/2000 dot com
The stock market is a forward looking system; it’s not really looking at companies as they are today…but what we expect them to be in the future.
If reality in the future don’t match expectations prices will fall. If people sell prices fall. When these things happen prices can fall a lot.
Markets going down happen pretty frequently; every couple of years we have a small “correction” and then every decade or so a major crash….learn to accept this
Let’s say the market is made up of Beanie Babies, Silly Bands, and Pogs. You and your friends in school all like these things. The kids in next grade down like them too, so their value continues to increase. Maybe you can trade a Pog for a candy bar. Eventually, the fad wears off and Pogs are not as cool. You’d have to trade 4 Pogs for a candy bar.
What would happen if Beanie Babies, Silly Bands, and Pogs ALL became uncool at the same time? Their prices would drop because your friend is willing to give 8 Pogs and a Beanie Baby for a single candy bar and when folks see that the price is dropping, they rush to get rid of their own stuff causing the spiral to continue.
That’s kind of what happens in a market crash. People don’t expect the stock to be as valuable in the future as it is right now and want to get rid of it (or have to get rid of it), possibly at a loss.
For investments, the price of an asset goes down when lots of people begin selling it for less than the current price. This creates a negative feedback loop, where falling prices cause them to fall faster.
You walk into McDonald’s and order a burger at the going rate. You see people cutting the line ahead of you and getting their burgers faster. This is because they are offering more than you are. In order to get your purchase completed quickly, you’ll need to offer as much money as they are, if not more.
The price of the burger is going up.
In a selling market, this is flipped. You put your burger up for sale and nobody is buying. You look and see that prices are lower than what you are asking. You mark the price of your burger down. It still doesn’t sell, you mark it down again and again. The price of the burger is going down.
You’re trying to get rid of this depreciating asset, and so is everyone else, causing the price to crash.
This can happen for a single stock, the entire stock market, housing, cars, etc. The cause can be a multitude of factors (glut of supply, potential regulation, corporate bankruptcies), or a single overwhelming factor (Covid). It results in a bunch of people trying to get to the emergency exit before you and dump their assets before the prices fall further.
Value is a concept. Things that were valuable on one day may not be valuable the next. Or vice versa. If enough things of the same type (homes, cars, stocks, banks, precious metals, etc.) all see enough of a shift at the same time… the market can crash. Investors aren’t usually LOOKING for losers. They want safety or a return on investment. So, the owners of the commodity lower their prices… and lower them more… and lower them more… until they hit a place that people are willing to buy in again.
A market crashes when human emotion gets out of control when trading goods. Everything we trade between each other has extrinsic value, or worth based on how much other people want it (demand) and how hard it is to obtain (supply). (Dirt is cheap because there’s lots of it and not many people want it, but land is expensive because there’s only so much of it on earth and too many humans want it) Now this value changes all the time, and that’s fine, but if the value, for say, bitcoin, drop too fast, all the people watching will panic because they assume that all of the Bitcoins they have could soon be worthless, so what do they do? Sell the Bitcoins while they’re still kinda valuable. But uh oh, now there’s more supply and less demand for Bitcoins, that makes them cheaper, making more people sell, making it cheaper, making more people sell, etc, creating a feedback loop where the Bitcoin becomes completely useless as a commodity. Basically people’s reluctance to buy is linked to people’s desire to sell, this pushes the value down exponentially. That’s a market crash.
Now, what would.cause that initial big blip that triggers the crash? There’s lots of reasons but one big one is when people get hyped up and buy into it, causing an artificial rise that’s not linked to supply and demand. This rise “fad” is called a bubble, and bubbles pop.
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