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Market Crash: What Does It Mean?
The phrase “stock
market crash” brings to
mind images of speeding ticker tape machines and panic on the
trading floor. The common perception is that stock market crashes
are random and unpredictable phenomenon. There is, however,
a pattern to the markets larger fluctuations. The market crash
is a familiar term but an unfamiliar concept.
To understand what happens in the market when a crash occurs,
we first need to look to the period that precedes
a crash. The cycle begins at a time when the stock market is weak and
people are generally pessimistic about the financial future
of themselves and country. The bear market has caused most
people to sell many stocks in order to save some of their investment.
This is the point where the smart investors can pick up undervalued
stock at bargain prices. These smart investors know that the
market will be turning in the near future and they can resell
these stocks for a much higher price. This accumulation of
undervalued stock causes the market to start to rise. The rising
stocks will attract the attention of mutual funds, and as the
mutual funds invest in the stock, billions of dollars are reintroduced
to the market place. Mutual fund investments cause the market
to gain even more as do investments by institutional investors.
At this point, the market has begun to stabilize and stocks
are no longer at bargain prices. Stock prices most likely reflect
the intrinsic value of the stocks. Those who invested early
have large profits.
The average investor though may still be skeptical about the
stock market, given the recent bear market. As the stock prices
continue to stabilize and more institutional investors get
re-involved in the stock market, the individual investors begin
to notice. The individual investors began buying stocks the
market is flooded with capital since the individual investors
make up the cast majority of total investors in the market.
This
bull market exists as long as the market is on the rise
and all stock involved are all gaining in value. Bull markets
make everyone happy. Investors and companies alike are making
money and enjoying it. There is a kind of euphoria in the country,
and a feeling that things will only continue to go up from
here.
At the peak of a bull market, many companies “go public” or
make stock available for purchase to the public. An IPO is
the term used when a company goes public. The reason IPOs show
up when the market is in a bull period is because companies
want to benefit from investor confidence. When individual investors
are more optimistic, the company can gain the highest possible
stock price. Individual investors often buy into IPOs with
dollar signs in their eyes and anticipating instant riches
from getting in on the ground floor of a company’s stock history.
Investing in IPOs is traditionally the method by which most
small investors make their money. The bull market is further
fueled and stocks begin doubling and tripling in value.
At this point, those smart investors who purchased the undervalued
stock at the beginning of the cycle are sitting in a prime
position. At the perceived top of the bull market these investors
can sell their now overvalued stocks before the prices start
to drop. In the height of a bull market, there are often incidents
of widespread greed. Corporate scandals arise, retail investors
start to use margin investing to gain more stocks, and irrational
purchases are made. The market is perceived to have no end
to its growth so people start doing whatever they can to gain
more stock with the false expectation that they will be able
to sell for profit later.
Once mutual funds and individual investors have fully invested
their capital, the market becomes “overbought.” At this point
the market can only go down. The speed of the downward trend
is determined by the amount of negative news. As there are
negative reports about stocks losing value, this causes more
investors to sell and the cycle expands exponentially. The
market always falls quicker than it has risen. If everyone
tries to exit at the same time, there are no buyers for the
stocks. If there is enough of a lack of buyers, the market
can crash entirely. The capitulation of the market occurs when
a massive amount of individual investors leave and the market
bottoms out. # # # # # SolveYourProblem.com : 2007
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