What Leads to a Crash of the Stock Market?

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It was the year 1720 that the world witnessed the first crash of a stock market. Ever since then every investor tries to forecast the next crash. So what makes a stock market crash? Everyone will have a different answer to this question, some of which might even sound weird. What you should be concerned about is the time when a market will likely crash. This will help you stay away from the market and you will not have to face any adverse consequences.

Let us take a closer look at the situation, and you will be able to understand what is involved. We will first explain the operation of a normal market and will then detail the circumstances that lead to a crash.

Suppose that you sell dresses in three colors: red, blue and white. The red dresses are wanted by everyone; the blue dresses are hardly lifted off the shelves. As for the white dresses, they are sold moderately. Realizing this, you increase the rates of the red dresses so that you can enjoy increased profits, and offer a slight discount on the blue ones so that they are sold as well. This is how supply and demand operates in every market. When demand is high, prices rise and when demand is low, prices fall.

After a few days, your dresses stop being sold. You reduce the rates slightly until you hear the news. The dresses are no longer fashionable, and that is when panic occurs in the market. You reduce the prices even more, but so do your competitors. When the prices plummet extremely low, it crashes. The same is the case with a stock market; just substitute the dresses for the stocks.

In a healthy market, prices depend on demand and supply of the stocks. However, when investments reduce and there are not enough buyers around, prices fall. This is acceptable; the situation turns bad when there is a buzz of some negative news. Consequently, selling becomes intensified and if technical indicators are breached, prices fall rapidly. Investors lose their values and as losses try to recover, even more selling occurs. The end result is a crash of the stock market which occurs when there are more sellers than buyers.

So whenever the market witnesses more selling, you should take a step back because it will likely lead to a crash.

Source: www.dailyfinance.com

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