Financial wonks: What constitues a Stock Market Crash?

[debbierlus]

The stock market has lost a few hundred points this week. It is down about 100 points right now. What would be considered in today's market, a stock market crash? Do you think it will happen very soon?

I don't understand much about this type of thing. I know one of the major investment firms issued a 100 percent chance of recession report this week.

[Pale Blue Dot]

1. So far, this isn't a crash.

It's more like a slow death spiral.

[bemildred]

2. IIRC a "correction" can run 15-20% easily.

For a crash you have to beat that. I think of crashes as being well over 30% losses all the way down to pennies on the dollar left.

[Zywiec]

3. Here's what the Dow Jones was for the last couple of years

17-Jan-07 - Closed at 12,577.15
17-Jan-06 - Closed at 10,896.32
18-Jan-05 - Closed at 10,628.79

Right now the Dow is 12,374

[debbierlus]

4. So, it is a correction?

Thanks, just needed a little context.

[NewJeffCT]

7. too early to tell

but, see my post below for actual "crashes"

if the Dow heads below 10K, then we can call it a crash.

[Zywiec]

8. It seems to be less than 1% difference from one year ago

I'm no analyst, but I wouldn't think that constitutes a market crash.

[A HERETIC I AM]

5. There is no clear definition, percentage wise, anyway of what constitutes a "crash"

According to this Wikipedia entry;

A stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market. Crashes are driven by panic as much as by underlying economic factors. They often follow speculative stock market bubbles.

Stock market crashes are social phenomena where external economic events combine with crowd behavior and psychology in a positive feedback loop where selling by some market participants drives more market participants to sell. Generally speaking, crashes usually occur under the following conditions: a prolonged period of rising stock prices and excessive economic optimism, a market where P/E ratios exceed long-term averages, and extensive use of margin debt and leverage by market participants.

There is no numerically-specific definition of a crash but the term commonly applies to steep double-digit percentage losses in a stock market index over a period of several days. Crashes are often distinguished from bear markets by panic selling and abrupt, dramatic price declines. Bear markets are periods of declining stock market prices that are measured in months or years. While crashes are often associated with bear markets, they do not necessarily go hand in hand. The crash of 1987 for example did not lead to a bear market. Likewise, the Japanese Nikkei bear market of the 1990s occurred over several years without any notable crashes.

In 1987 the market lost 22.6% in one day. In 1929 the market lost 23% over 2 days trading. The DJIA is currently down just over 12% from it's high last October 11 of 14,198.09 (Although it never "closed" that high. 14,198 was the intraday high) so this decline has taken 3 months. It is most certainly a Bearish trend, but single digit declines on a given day do not constitute a crash.

[debbierlus]

12. So, would you say if we lost 10% in a three day period, that would equal a crash?

[NewJeffCT]

6. A 200 point loss isn't all that much - even 400 in the long-term

A 200 point loss isn't really all that much overall - only about 1.5% of the market.

The market is around 12,300 now. For it to crash in one day like it did in 1987, it would have to register a 2,800 point drop in one day (22.6% of 12,300)

In October of '87, the markt saw a one day drop from 2,247 to 1,739.

The crash of the Great Depression in 1929 saw several big drops quickly, but none as big as that one. In about one week, the Dow suffered consecutive drops of about 13% and then 12%, (Oct 28 and 29, 1929) and then 10% a week later on 11/5. The equivalent today would be losing 1,600 in one day, then 1,284 the next day and then next week, losing 942 in one day, taking the market to around 8,600 or so.


http://www.forbes.com/2007/02/28/dow-jones-worst-days-biz-cx_daa_0228dow_slide_12.html?thisSpeed=15000

[debbierlus]

13. Interesting to see the number comparisions

The stock market boggles my mind. It seems so psychological. My dad is vested pretty heavy in it, but he is one of those 'elite' managers accounts & he seems to be pretty diversified. I don't have a penny in myself.

[TomClash]

9. You would need about a 15-20% decline and then another sharp drop

That's what happened in 1929. The Dow was at about 14,200 in October. It's at 12,400 now. That's an 1800 point drop - about 12-13% in the last three months.

There are circuit breakers starting at a 10% decline at the NYSE that suspend trading if the DJIA index declines dramatically during a day's trading session. The point is to provide a psychological cooling off period to halt or at least cushion very big sell-offs.

[A HERETIC I AM]

10. Summary of the current "Circuit Breaker" trading curbs.

Circuit Breaker Summary
Effective: January 2, 2008


Circuit-Breaker Levels for First-Quarter 2008

The New York Stock Exchange resets its "trigger levels" each quarter to halt trading in the event of intraday DJIA declines of 10%, 20% or 30%. The triggers are converted into point values at the beginning of each calendar quarter by using the average closing value of the DJIA for the prior month (average closing value of DJIA in December, 2007 was 13,500). The point values of the declines are rounded to the nearest 50 points.

The duration of the trading halts are then determined by the time of day and extent of the decline. Trading in all stocks on the exchange will halt for the time periods specified below (all times are eastern):

Level 1 Halt

In the event of a 1,350-point decline in the DJIA (10%),

Before 2:00 p.m. Trading halts for one (1) hour
Between 2:00 p.m. and 2:30 p.m. Trading halts for 30 minutes
After 2:30 p.m. No trading halt

Level 2 Halt

In the event of a 2,700-point decline in the DJIA (20%),

Before 1:00 p.m. Trading halts for two (2) hours
Between 1:00 p.m. and 2:00 p.m. Trading halts for one (1) hour
After 2:00 p.m. MARKET CLOSES for remainder of session

Level 3 Halt

In the event of a 4,000-point decline in the DJIA (30%),

Regardless of time of day MARKET CLOSES for remainder of session

PROGRAM TRADING COLLARS

RULE 80A

-Effective late in the fourth quarter of 2007, Rule 80A that applied to “program trading collars” was rescinded by the Securities and Exchange Commission (SEC). The rule required that for any component stock of the S&P 500, whenever the NYSE Composite Index (.NYA) advances or declines by a predetermined value from its previous day’s closing value, all index arbitrage orders to buy or sell were limited. The value at which these tick restrictions were imposed was a 2% move in a trading session based on an average closing value for the NYSE Composite calculated over the prior month’s closes. The “limit” remained in place until the NYSE Composite moved 1% in the opposite direction.

The change was made to eliminate the restriction because the volatility that was envisioned by use of the “collars” when they were formulated in the late 1980s is not as meaningful today. The rule addresses only one type of trading strategy, namely index arbitrage, whereas the number and types of strategies have increased markedly in the past 20 years, thus adding to and decreasing the amount of volatility. As markets have continually and significantly evolved in the years since this rule was adopted, other trading regulatory restrictions have been removed.

RULE 10a-1

-In July 2007, The SEC ended price tick restrictions on short sales, a regulation that had been adopted almost 70 years ago. This rule had banned shorting a stock until after an uptick in the shares, an attempt to slow down the decline in a stock that was being heavily shorted.

[TomClash]

11. Very good, thanks, I know what they are

I was going for brevity, rather than amplitude.

[debbierlus]

14. I didn't know that - thanks for the data!