Causes Of A Stock Market Crash (2)

While crashes are usually complex scenarios as a result of both internal and external factors, there are certain events that can point to an incoming crash.

One of the worst things that can happen to any stock market investor is to be caught up in a stock market crash. While crashes are usually complex scenarios as a result of both internal and external factors, there are certain events that can point to an incoming crash.

In our last post, we considered some internal factors that could cause a stock market crash. In this post, we look at more possible causes both as a result of internal market activities and external environmental events.

High Rate of Leverage

Leverage has to do with borrowing money to fund an investment. While this can be a very lucrative method of financing investments where things are going well, in a situation where the market enters a bear trend, it can lead to a crash in the overall stock market.

This is because where the investor makes a gain, he or she can conveniently repay the loan whilst keeping profits earned. On the flip side, if prices keep crashing, levered investors will be forced to sell their investments so as not to end up repaying too much out of pocket and this will, in turn, drive prices even further down.

Environmental Disasters

Environmental disasters are unpredictable. The pandemic that is #Covid19 was not accounted for in the projected outlook of the stock market by experts across the world, yet, it is a reality that we have all come to terms with. Environmental disasters can be either man-made or natural.

However, the impact of the disaster, in whatever form it takes, can be fatal enough to cause a stock market crash. A good example is how markets were forced to close for six full days following the 9/11 attacks in 2001. Crashes have been caused by earthquakes, Tsunamis, or floods as well.

Interest Rates And Inflation

Rising interest rates and rising inflation rates are not only bad for an economy, but also have the power to cause stock market crashes. On one hand, higher interest rates will naturally mean higher borrowing costs.

Where it costs more to borrow, people will borrow less and this will reduce the rate of investments, ultimately causing stock prices to crash. For investments like real estate, high inflation rates will also put pressure on related stocks.

More so, with inflation, input prices are higher so investors can purchase fewer stocks, business revenues and profits crash, and the economy typically moves at a slow pace until order is restored.

Political Risk

Political risk, while generally caused by specific countries, can lead to global recessions as a result of international trade – especially where a large economy is involved.

The stock market requires a level of stability to do well and political risk is anything but stable. This form of risk can take the form of wars, terror attacks like Boko Haram, and politics-induced violence.

Since an investor will most likely not invest in any nation plagued by political instability, such events reduce the flow of investments in stock markets, and this could lead to a stock market crash.

The best investment strategy for periods as these is to focus on your investment goal, set up hedging systems (or stop loss orders) to curb possible losses, while also staying updated with investment or financial information until the evil passes.

Written by Lawretta Egba.