Market Crash

What Exactly is a Market Crash?
“Market crash,” just the sound of the phrase makes most people shudder. But what exactly is a crash, and why do they occur? The answer lies within human psychology. People love bull markets. Bull markets have the uncanny ability to change the collective attitude of society. In a quickly rising market, even the words of rather prosaic business pundits become aform of entertainment. This is what happened in the tech boom as Fed Chairman, Alan Greenspan, became a worshipped celebrity. Eventually the euphoria changes into downright pessimism as the inevitable market crash occurs. Later on, the cycle repeats itself. In order to fully understand these events, we must learn about behavioral finance.
In financial markets, the “majority is always wrong.” Whenthe investing majority or the crowd is overly bearish, this is the best time to be buying stocks. When the crowd is overly exuberant, this is the time to be selling stocks. The financial markets work in this ironic way because not everyone can win in the market. If it were possible for everyone to win in the markets, this would mean that money is being created from nothing. The creation of money,in this manner, is impossible. Therefore the markets are a zero-sum game. Zero-sum means that for every winner, there is a loser. The winner takes the losers money. Zero-sum games are games where the amount of "winnable goods" is fixed.

The Start of a Bull Market
The bottom of the market starts at a time when the stock market is weak and the general population is pessimistic. At this pointmost investors sell after having endured a long and torturous bear market. This extreme pessimism found at a bottom is always irrational and undeserved. Now the market is undervalued and is a bargain. Savvy investors, the smart money, buy bargain stocks knowing that they will be able to sell them higher in the near future. Smart money buying, called accumulation, causes stocks to rise. The smartmoney often consists of NYSE specialists, Nasdaq Market Makers, hedge fund traders and corporate insiders. These traders have access to information that the general public does not.
Rising stocks eventually gain the respect of mutual funds, as billions of dollars of capital is introduced into the market place. Mutual fund investment causes the stock market to advance in a powerful manner. Much ofthe steady large trends are powered by mutual funds and other institutional investors. After the stock market has gained, stocks are now fairly valued and are no longer considered bargains. The smart money is now sitting on a large profit, as well. The average investor is still skeptical, however.
As bull market events unfold, retail investors begin to take interest in stocks. Retail investors,or the unsophisticated little guy, make up the vast majority of investors. This group does not invest for a living. Retail investors often make investment decisions based on what they read in financial magazines, from their brokers and from tips from friends. As the flood of retail capital is invested, the market soars, causing great euphoria. At this point in the cycle, many companies becomepublic, or launch an IPO. Companies go public when investor sentiment is most optimistic so as to gain the highest possible stock price. IPO’s generate even more optimism as unsophisticated investors buy into the fallacious thoughts of instant riches. Now is the time when many small investors become wealthy. In this phase, stocks are doubling and tripling as the media cheers on the advancing bullmarket.
At this point, the smart money sells, or distributes, the now overvalued stocks to overconfident retail investors. The smart money knows that overvalued stocks are no longer worthy investments, and will soon drop in value. Widespread greed always occurs, in some form, at stock market tops. Sometimes this greed takes form as accounting fraud where companies over inflate their values. Other...