Stock Market Crashes - How They Happen And How To Avoid Them

Every investor's worst nightmare includes stock market crashes that wipe out their life savings, but there are a few precautions you can take. The first major Wall Street wipe-out occurred in 1929, followed by the next largest, in 1987. You have to keep in mind that stock market crashes can be indicative of economic conditions that are about to change for the worse. Some experts say market conditions precede actual conditions by 6 to 9 months, since stock market crashes are based on pessimistic outlooks by leading economists.

The financial markets are filled with emotional traders, but there are many technical analysts that predict certain behaviors, including stock market crashes. If the market appears to be "over-bought" (or in a stock market bubble), it means that shares are trading at higher than their actual financial statements would indicate. If this happens on a broad-based level because investors aren't getting enough interest from their savings accounts, for example, a bubble is created where the stocks are "over-priced" and a correction or profit-taking will occur. Drops in the market are known as "corrections" where shares drop by 5% or more. Stock market crashes can have drops that exceed 10%, 20%, 30% and finally 40% of market prices, like in the 1920's.

In today's marketplace, there are many institutional traders that have stock-picking software programs in place. When these shares reach a certain point, there could be a drastic sell-off or dumping of shares and profit-taking occurs. If this happens on a broad scale, the average investors start selling their shares and the beginnings of a major correction takes place. It can be easy for stock market crashes to occur in this automated process, but there are safety nets in place, including a trading halt, when too drastic of a drop occurs.

The main thing to keep in mind is that stock market crashes can happen suddenly and quickly and you will see your profits wiped out in a few days. The most recent drops in market prices have cost a lot of people their original investment. For this reason, you need to constantly monitor the marketplace and if you use stock-picking software, you might have the same advantage that large, institutional traders have at their disposal.

Nobody wants to have their savings wiped out, but when interest rates start moving up, investors will move funds to higher-interest savings and out of shares. Since many businesses have borrowing lines of credit tied to prime interest rates, jumps in the rate cost every business more in operating expense, which cuts profits. For this reason, you could see investors selling out their positions, which causes a snowball effect on a downhill slope, especially with automated institutional trading.

This scenario isn't meant to scare you, but you should be educated about stock market crashes to start seeing the signs of one on the horizon. If you have utilized options to protect underlying shares or followed the basics of investing, you purchase low and sell high. You may come to see stock market crashes as a purchasing opportunity. You should learn as much as you can from investing books, stock tutorials and even, brokerage newsletters and websites. There are plenty of products on the market to educate the non-technical investors that might not see all the signs of a major market downturn.