The Anatomy of Stock Market Crashes

By | November 26, 2021

What are the attributes of a stock market crash? Today markets around the world are falling sharply, this is mostly due to Covid-19 variants and other economic factors, here is the anatomy of a stock market crash, note that this also affects Forex, Cryptocurrencies and others.

Stocks November 2021

Stock Market Crash Due to Covid Fears

What makes a market fall?

Crashes do not give any prior warning before they occur, there are always indicators that can help however they are not guaranteed to predict a market fall. If crashes could be predicted with any degree of reliability, then there would never be any crashes. Stock market crashes also end just as suddenly as they began, however note that some recoveries can takes days, months or even years. I am aware that there are some people that do try to predict crashes, but my personal view is that your energy would be better expended on other things.

Take a look at any chart of a crash, and it would be obvious to you that a distinguishing feature of the crash action is it’s sharpness. The crash looks just like the edge of a cliff, and in fact is just as dangerous. The sharp falls of market crashes are aggravated by a massive imbalance between buyers and sellers. Basically, everybody is heading for the exit at the same time. This is why understanding technical analysis is important, if you have cash waiting to be deployed, market crashes bring opportunities for investors.

Normal market action is characterized by trend moves punctuated by trend retracements. In fact, the Elliot Wave theory is based on this very phenomenon. However, during a crash, price action is generally all one way – down, with very little upward movement. It is this feature that makes crashes so damaging to one’s wallet. Usually, highly leveraged investors get liquidated during these times.

Very Extreme
If you plot a bell curve on the daily price changes, then a crash will lie at the extreme left of the curve, and is what statisticians call an outlier. This is why crashes are such rare events. Understanding their rarity, smart investors are always prepared for a crash. One way they do this is by using position sizing techniques that limit the amount of investment capital they have at risk in Forex, in the Cryptocurrency and Equities Markets, this is called dollar cost averaging.

Across the board
When a crash occurs, it is safe to assume that 99% of stocks will bleed red. There will be few, if any, survive. Market makers mark everything down, whether justified or not, so even fundamentally sound stocks will not be spared. Only a few sectors are benefited, in this case, Covid-19 seems to be helping health stocks like Pfizer or stay at home companies like Zoom.

There are few market events as traumatic as a stock market crash. Anytime you witness any market action that is sudden, sharp, relentless, and statistically extreme to the downside, the odds are that you have a crash on your hands. You will be very lucky indeed if any of the stocks in your portfolio comes out unscathed. However, this also brings opportunities to investors holding cash, if you are a long term investor, and have other sources of income the best thing to do is either to average down your positions or do nothing, specially if you do not have a reason to sell.