A Stock Market Crash

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Many people are frightened by the stock market because of the stories about past market crashes. Yes, those crashes did happen, but the fear surrounding them is more hype than substance.

TIP

Your fear that the market will collapse as it has done in the past is best dismissed by learning that the probability of another crash is infinitesimal and that the damage caused by previous crashes was not as bad as the public's perception of them.

On October 29, 1929, the Dow, a measurement of the stock market as a whole, fell 30 points to close at 230.07. This represented a drop of almost 13 percent in the whole market. The loss of market value was roughly $14 billion, a staggering sum even now. This meant that $14 billion of the total amount invested into the market by people and by entities such as pension funds was simply gone. The severe ramifications of this event affected even those people who had not actually invested in the market. The subsequent depression, while not directly a result of the stock market crash, further entrenched the idea that investment in the stock market would later reduce the investor to selling apples on a street corner while wearing a barrel. Finally, the stories and depictions of grown men throwing themselves off roofs and crying at their desks assured the general masses that stock investments could only cause heartache.

In addition, 58 years later, the crash of 1929 was surpassed by Black Monday and Black Tuesday on October 19 and 20, 1987, respectively. The Dow's drop of 508 points represented more than a 22 percent drop in the total value of the market and over $500 billion of investor dollars. The crash of '29 was a picnic by comparison.

These events have been highly analyzed , and rational and reasonable explanations for both crashes have been presented and generally accepted by the marketplace . The crash of 1929 was attributed to the market's practice of accepting credit to pay for stock purchases. That practice has long since been cancelled. In addition, program trading, or the ability to trade stocks in a matter of seconds through the use of computers, has been blamed for the crash of 1987. Both of these explanations are probably not particularly important, however, to the people who owned stock at the time of the crashes. The focus is not on why the money was lost, but on the fact that the money was lost.

Two things are important to remember in attempting to place investors' fears in the proper perspective in light of these unfortunate events.

The most obvious is that the crashes are infrequent events. Twice since the inception of the stock market in 1792 is not a bad track record. Your chances of being involved in a stock market crash are slim to none. Once invested in the market, you will come to realize that the likelihood of a market crash is so infinitesimal as not to be a concern anywhere in the financial community. By sharing in that confidence, you will be able to discard your fear altogether.
Persistent new investors will continually ask, "But what if ?" After all, a chance, no matter how small, of the market's crashing does exist. This question has arisen as a result of the recent collapses of the Asian and Russian markets. It should be pointed out that while markets around the world were crashing, often as a result of the ramifications of prior crashes in other countries , the American market remained stable. The American economy is 16 times larger than its next -largest competitor, a fact that lends an incredible amount of stability and strength to American stock markets. Crashing them simply isn't that easy.

In the highly unlikely case that the markets do fail, remember that in both crashes the average investor may have suffered heavy losses but was not wiped out totally. A loss of 12 to 22 percent of your initial investment is without a doubt disastrous, but it simply isn't that significant when compared with the amount of money that the investment probably had made. In the same train of thought, both of the crashes were preceded by extended favorable, or bull, markets.

Happily, the history of the stock market has taught us that bull, or favorable markets tend to last longer than bear, or unfavorable, markets. The term "bull" market was taken from early bear trappers. They were notorious for depending on the price of fur to drop so they could purchase pelts cheaply to cover prior options trades they had made. A popular sport at the time, bull and bear baiting, depicted the bull and bear as natural enemies, so the term bull market was used to describe the opposing rising market.

Plain English

The terms bull market and bear market are used to describe the conditions of the market. Extended periods when stock prices continue to rise are referred to as bull markets, and periods when stock prices fall are known as bear markets.

In 1929 the stock market had reached a new high of 469.49 the month before the crash. In 1987 the stock market had also reached a new high of 2,722.42, two months before the crash. It is safe to assume, then, that a significant portion of the money being lost by investors was the profits that they had made from their investments. This doesn't mean that their losses weren't real, however. If at the end of the day you still have the money you put into the investment, it is difficult to say you lost anything other than the time that your money was occupied and, of course, any opportunities which were missed as a result of it.

Many fears may be somewhat justified. To not invest because you fear a stock market crash is not one of them.

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