When there is a stock market crash signaling a recession, stagflation, or severe depression, what we are experiencing is a sudden and very large drop in the value of stocks in the markets, causing a hasty sale of stocks and other securities by investors and some institutions. When the underlying value of the companies that issue the shares suddenly collapses, their price also falls proportionally and the resulting situation is the loss of much of the money that people invested and, in extreme cases, as in the Great Depression of last century, the loss of all your invested capital.
The hackneyed argument of the stock market as a capitalist den of speculators and millionaires is false. The indisputable reality is that there are countless small investors who have accumulated their life savings and invested them in stocks and that almost all citizens who have worked in the country have their pension funds invested in mutual funds and securities that pay substantial interest or dividends or in investment programs known as 401(k) that exempt them from taxes.
The serious problem for those who depend on these investments to have an additional income or a decent pension is when a market collapse occurs precisely when they have to sell some of these securities to cover unforeseen expenses or when their pension income is barely enough to cover essential expenses of their monthly budget.
What Causes a Stock Market Crash?
A stock market crash is caused by two circumstances: a dramatic drop in stock prices and the resulting panic. Here's how it works: Each of the shares owned represents a small stake in a company, and the investors who buy them make a profit when the value of their shares increases or when they receive interest or dividends approved by the company's board of directors. The price of these shares depends on the opinion of the majority of investors at that time about the value and future prospects of that company. So if they think the company they're investing in is headed for tough times, they sell those stocks in an attempt to exit before their value falls.
The reality is that panic plays as much (or more) a role in a stock market crash than the actual economic problems that cause it. There is an obsessive reaction that irrationally drives scores of investors to dump their shares at whatever price they can get, and the market plunges into a full-blown crash.
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