Stock Market Crash

A stock market crash is an abrupt and severe decline in the prices of shares across a broad section of a stock market. There is no official threshold. The term is generally reserved for falls of well over 10 percent in a major index within a few days, marked by heavy volume, disorderly trading and widespread fear. A crash is defined by speed as much as by size.

It differs from a correction, conventionally a fall of 10 percent from a recent high, and from a bear market, a fall of 20 percent or more that may unfold over months or years. A crash can begin a bear market, as in 1929, or be followed by a quick recovery, as in 1987. Crashes often follow a period of rapidly rising prices and may be linked to wider economic crises, but not every crash leads to a recession.

• 1929. After a long boom, the New York market broke in late October. The Dow Jones Industrial Average fell about 13 percent on Monday 28 October and about 12 percent the next day. The decline continued in stages until July 1932, by which time the index had lost close to 90 percent of its September 1929 peak. The crash is associated with the start of the Great Depression.
• 1987. On 19 October, known as Black Monday, the Dow fell 22.6 percent, still its largest one-day percentage loss. Markets around the world fell with it. The economy did not enter recession and the index regained its earlier level within about two years.
• 2000 to 2002. The collapse of the dot-com boom was slower. The Nasdaq Composite fell by more than three quarters between March 2000 and October 2002.
• 2008. During the 2008 financial crisis, share prices dropped sharply after the failure of Lehman Brothers in September. The S&P 500 lost more than half its value between October 2007 and March 2009.
• 2020. As the COVID-19 pandemic spread, the S&P 500 fell about 34 percent between 19 February and 23 March, among the fastest declines of that size on record. Prices recovered within months after large-scale central bank and government support.

A flash crash is a related but distinct event, in which prices plunge and rebound within minutes, as on 6 May 2010.

Crashes rarely have a single cause, and the trigger is often minor compared with the fall that follows. Several conditions recur.

• Stretched valuations. Prices that have risen far above levels supported by earnings, as in a bubble, are vulnerable to any change in sentiment.
• Leverage. Investors who have borrowed to buy shares must sell when prices fall and lenders issue a margin call. Forced selling pushes prices down further and triggers more calls.
• Mechanical selling. Strategies that sell automatically as prices fall can reinforce a decline. Portfolio insurance, a hedging technique related to constant proportion portfolio insurance, was widely blamed for intensifying the 1987 crash.
• Evaporating liquidity. In a panic, buyers and market makers withdraw, so even modest sell orders move prices a long way. Liquidity is thinnest exactly when it is most needed.
• Herding. Fear spreads quickly, and investors sell because others are selling, a pattern studied in behavioral finance.

Crashes are far more frequent than standard models predict. If daily returns followed a normal distribution, a fall like that of October 1987 would be effectively impossible. Its occurrence is evidence that share returns have fat tails, and it changed the pricing of options: since 1987, protection against large falls in equity indices has been persistently expensive relative to other options. Rare, high-impact events of this kind are sometimes described using the idea of a black swan event.

After 1987 a presidential task force in the United States, the Brady Commission, recommended coordinated trading halts, and exchanges introduced the circuit breaker. Under the current United States rules, trading across all share markets pauses for 15 minutes if the S&P 500 falls 7 percent or 13 percent from the previous close, and stops for the day at 20 percent. These halts were triggered four times in March 2020. Individual shares are further protected by price bands that pause trading after rapid moves.

Other safeguards include margin requirements that limit borrowing, capital rules for brokers and banks, and restrictions on certain forms of short selling during stress. Central banks have also acted to stabilize markets, by cutting interest rates and supplying liquidity to the financial system, as the Federal Reserve did in 1987, 2008 and 2020.

A crash destroys paper wealth, weakens confidence and can restrict the supply of credit if banks and brokers suffer losses. The economic damage depends heavily on the condition of the financial system and on the policy response. The 1929 crash was followed by bank failures and a prolonged depression, while the 1987 crash had little lasting effect on output.

Recovery times vary widely. The Dow did not regain its 1929 peak until 1954, whereas the losses of early 2020 were recovered in about five months. Crashes cannot be predicted reliably, and many forecasts of imminent collapse have proved wrong.

• Federal Reserve History
• U.S. Securities and Exchange Commission