What is Stock Market Crash?

Key Highlights

• A stock market crash happens when stock prices suddenly and sharply go down.
• It could mean a long time of falling prices or show that the economy is facing difficulties.
• The effects of a stock market crash reach different areas, affecting how stable the overall economy is.

What are the Causes of Stock Market Crash?

There are different reasons why the stock market crashes in India, and it usually happens because of a mix of things. . Following are the reasons that contributes s to stock market crash in India

• Speculation

Speculation means people taking big risks hoping to get a lot of money back. Back in 1929, there was a crash because lots of people were making risky bets in the stock market, and it all went wrong. Another example is in the early 2000s when there was a problem with tech stocks, and people were investing a lot in dot-com companies, making the market shaky. In 2008, the crash was linked to risky activities in real estate, helped by not-so-strict rules in the banking sector.

• Risks Associated with Leverage

The risks that come with using a lot of borrowed money, known as leverage, become clear, especially when the economy is doing well. Leverage, which is like using borrowed money to make more money, might seem like a good idea at first.

Let's take an example: Imagine someone invests ₹5,000 in stocks, and the value goes up by 20%, making a profit of ₹1,000. Now, if this person borrows an extra ₹5,000 and invests a total of ₹10,000 in the same stocks, their gains double to ₹2,000.

This seems clever when the stock market is doing well, but it can be risky when the market isn't doing so great. For instance, if the ₹5,000 stock investment drops by a significant 50%, someone who didn't borrow extra money would still have ₹2,500. But if they borrowed an additional ₹5,000, a 50% decline would mean they lose all their invested money.

The danger is that using too much borrowed money (leverage) can lead to big problems. When the stock market goes down, businesses and investors with a lot of borrowed money may have to sell their assets quickly. This rush to sell things makes prices fall even more, creating a cycle that can make the overall economic situation worse. So, while borrowing money to invest can be good when things are going well, it can be risky if the market takes a downturn.

• Impact of Inflation Rates

Elevated interest rates, indicative of rising borrowing costs, possess the potential to impede consumer spending, subsequently resulting in a decline in stock values. For example, a notable 6% increase in the 30-year mortgage rate could significantly decelerate the housing industry, thereby causing a downturn in homebuilder stocks as demand weakens.

• Political Environment

Market preference for stability encounters obstacles in the face of wars and political risks. The presence of uncertainties surrounding political decisions tends to disrupt investor confidence, fostering a sense of apprehension that contributes to a general downturn in the market as investors become more cautious in their engagements.

• Tax Changes

Adjustments in tax policies, such as implementing deductions from the tax base to counteract the impact of inflation on nominal income, wield influence over investor behavior. This strategic approach aims to mitigate the consequences of inflation by maintaining nominal taxable income at a constant level while the real taxable income experiences a reduction.

These are just a few of the significant factors, and more often than not, stock market crashes result from a combination of these influences rather than a single factor.

Interactions of Bull Markets, Bear Markets, and Stock Market Bubbles

In the world of finance, the way markets move is like a roller coaster ride with three main phases: the bull market, the bear market, and the stock market bubble.

• Bull Market

Picture a bull charging forward. That's how a bull market feels—stocks are going up, and everyone is excited. Investors are confident, and they believe the good times will keep rolling. Positive signs in the economy, strong company profits, and friendly economic policies all contribute to this upbeat atmosphere.

• Bear Market

Now, imagine a bear hibernating. That's a bear market—stocks are going down, and people are feeling cautious. It happens when there are economic problems, companies aren't doing well, or there are outside factors causing concern. During a bear market, investors often sell their investments to avoid bigger losses. Fear and caution rule the day, and the hope for a quick recovery fades.

• Stock market bubble

A stock market bubble happens when prices of assets, especially stocks, go way higher than what they're worth. This usually occurs because people are buying based on speculation, driven by widespread optimism and the fear of missing out on possible profits.Imagine a bubble where prices go really high, but they don't match the real value of things. This surge can't last long. Then, the bubble bursts, and prices drop quickly. This happens because people realize the high prices weren't real and were just inflated without any substance behind them.

• Interaction

Think of these phases like a connected circle that keeps going around. In a bull market, where prices are going up, a stock market bubble can form as more people start buying based on speculation. When the bubble bursts, it often leads to a bear market, where prices go down to more realistic levels. On the other hand, a bear market can set the stage for a new bull market as prices become attractive to investors looking for good deals. Understanding these market phases helps investors make smart choices during the ups and downs. It's like knowing when to enjoy the good times, be ready for a rough patch, or stay away when things seem a bit too wild.

Stock Market Crash in India

In 2008, when the whole world faced a big money problem called the global financial crisis, India also had a tough time in the stock market. This happened because a big company called Lehman Brothers in the United States fell apart, and it created a chain reaction affecting money markets globally, including India. The BSE Sensex and NSE Nifty, which are like report cards for the Indian stock market, showed that things were not going well. The values of stocks in India quickly went down, and many people started selling their stocks because they were worried. In a short time, the Sensex lost more than half of its value.

This crash caused big problems for India. It affected different industries and made the government create new rules to make the money system more stable. This event showed that what happens in one part of the world can affect other parts, and it also showed that countries like India, which are still growing and developing, can be easily affected by big problems happening elsewhere.

Conclusion

When the stock market goes down a lot, it shows that money markets can be uncertain, and it's important to have strong rules to manage the risks. People who invest money can lose a lot, confidence in the market goes down, and different parts of the economy might have difficulties. Looking at past crashes, like the big money problem in 2008, teaches us that we need to always be careful, ready to change, and take action to keep the market stable and help the economy grow in the long run. Even though crashes happen, how well societies and money systems bounce back afterward shows how we can recover and handle new challenges.