What Is a Market Crash?

A market crash refers to a steep decline in stock market prices over a very short period of time. Although the rate of decline and the period of time are nonspecific, typically a market crash occurs when a double-digit decline in stock prices is seen over a period of hours or days. Stock market crashes are driven by poor market conditions and consumer panic. The most famous stock market crash was in the US in 1929, and it began the Great Depression.

A perfect storm of market conditions must occur in order for there to be a market crash. Typically, inflated stock prices and consumer panic contribute to these conditions. Inflated stock prices are when profit and earnings ratios exceed the long-term average for the stocks, so the stocks are not necessarily worth the amount for which they are trading.

Once stock market buyers become stock market sellers, a complex psychological spiral can occur, and people can become panicked. After this occurs, more and more people begin to sell their stocks and a chain reaction begins to take place. Panic leads to more panic and more sell-offs. A stock market crash may not be representative of the economic conditions at a point in time; instead, it might be driven solely by psychological factors.

There are two euphemisms which describe the stock market at any given time: a bear market and a bull market. A bear market occurs when stock prices decline and stay low over a long period of time, like months or years. A bull market occurs when stock prices rise and stay high over a long period of time. Usually an extended bear market follows a market crash.

There are relatively few market crashes in the history of the stock market. Arguably the largest market crash began in the US in 1929, after the success of the roaring 20s. The Dow Jones Industrial Average, a composite of some of the top stocks available, plunged 23% over two days known as Black Thursday, October 24, and Black Tuesday, October 29. This crash led to the Great Depression, and the Dow Jones dropped 89% of its value from 1929 to 1932.

Many countries have implemented rules which cease trading when there are large drops in the value of stocks. This helps to prevent large panic-driven crowds from pulling their money from the market when it is most susceptible to a crash. These rules are known as circuit breakers or trading curbs.