Stock Market Crash

Stock market crashes can and do happen. The 1929 crash was one of historic proportions, where leveraged investors were wiped out when the selling started. Again the market crashed in 1987, when a long run of inflation and large investments in the stock market gave way, causing huge losses for everyone involved. There is much that we can learn from the 1929 stock market crash that will allow us to do better in the markets today.

Economics and Speculation

The 1929 stock market crash was brought on by a series of economic and speculative disasters. The Fed, newly created in 1913 to help stabilize the markets and bring about monetary policy reform, was largely to blame for what happened in the 1929 stock market crash. The governors of the Fed were inexperienced with financial markets and monetary policy because simply the Fed had never had to coincide its actions with Wall Street. Throughout 1929 and into the 1930s, the Federal Reserve allowed money supply to shrink by 33%, which exerted huge downward pressure on the markets as prices dropped due to deflation.

The Hidden Cost of Leverage

The problems of the 1929 stock market crash were highly leveraged. Even average investors were able to make stock trades equal to ten times the amount they had to invest. By putting up just $1000 in cash, investors could buy $10,000 of stock by borrowing the additional $9,000 from the banks.

It's now easy to see how the Great Depression was so intertwined. After a vicious bull market run, investors began to take profits out of the system and caused rapid revaluations of stock. Because it was so leveraged, just a 10% loss would create what is known as a "margin call," or when the collateralized portion of the loan is lost and the bank stops the trade to save their loan.

What happened when investors hit a margin call were huge sell offs, a rapid drop in stock prices, and millions of people with losses greater than what they had originally invested. On the hook as well were many banking institutions, which had either issued loans to investors for leveraged stock buys or had directly invested in the stock market themselves.

More Regulations Today Offer Very Little Protection

Today there are more regulations in places at all the major exchanges to stop a huge drop off from happening. In the clauses of virtually every stock exchange around the world, the markets are closed after a benchmark index loses a certain number of points in a day or a predetermined percentage loss.

Even with these stops in place, the sell off will now occur over many days instead of just one; however, that is only when catastrophic sell offs are hitting the market - not the once in a blue moon large sell offs that occur once or twice per year.

Leveraged stock market positions are only offered to the largest of investors and often will only let you use the leverage intraday, meaning that it is impossible to carry a leveraged position through the night. This leverage is also toned down to 2:1 or 4:1 instead of what was 10:1. In any case, the stops put in place on today's market cannot stop a full market sell off or a huge downturn, but instead make them slightly less painful for investors.