The overall performance of the market is calculated by taking into consideration the average of the top equity assets, and a sudden decline in these indexes is technically considered a 'crash' or 'collapse'. This decline can be attributed to numerous factors coming into play, all of which can be broadly categorized into economic and psychological factors.
As far as psychological factors are concerned, investor sentiment is by far the most prominent. In a growing economy, wherein the gross domestic product (GDP) is rising, consumer confidence is very high, and therefore, there are more investments in the market.
In such a situation, if the economy slows down considerably or the growth rate declines and goes below the expected growth, there is panic among investors, as a result of which they start selling off their stocks. This excessive selling of stocks eventually triggers a market collapse.
Mob Psychology and Negative Attitude
In most of the cases, the collapse is attributed to mob mentality and negative attitude on the behalf of investors. At times, a single event, such as a terrorist attack or a change in government, can also trigger a stock market crash.
This most often happens when the event in question creates panic in the market and investors, unsure about the future, start to sell off their stocks. When some of the top investors pull out of the market, other investors follow. As all investors are particularly interested in selling off their stocks, the price of various stocks declines.
When a particular asset is expected to gain value in the market, investors buy it with the aim of making profits in the future. As a number of investors buy this asset, there is a rise in its demand and fall in its price. This makes it appear as if the asset is going strong in the market, as a result of which more investors try to invest in stocks.
This inflates the price of the asset to a price beyond its actual value and at a particular point, it reaches a level wherein it becomes clear that the price is miscalculated.
This triggers a race to sell off the asset and thus, its price starts to fall. The panic caused by this decline in price prompts more people to sell off their assets, eventually leading to market collapse.
Aftermaths of the Crash
When markets crash, the economy loses a significant amount of money. The prices of essential commodities rise, while the currency value goes down, which leads to deflation. If the trend continues for a long duration, many firms become vulnerable to bankruptcy.
At this point, the government has to step in and guide the nationalized banks to reduce interest rates. Some investors cash in on the opportunity and buy stocks at a lower price which they sell when the markets become stable to gain profits.
If the investors' confidence in the markets and underlying economy is not restored, the crash can push the economy into recession.
It's wise to keep yourself updated about the developments in the stock market and keep a proper track of your investments. Consulting a professional expert can help you to make a decent amount of money, but a consultant will never understand the importance of your money like you do.