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Stock market crash

A stock market crash is a sudden and precipitous drop in the stock market averages.

Expanded Definition

The key words are sudden and precipitous. In stock market history, there are many short periods of time where the market averages fell precipitously, but none more dramatic or storied than the big two:

Unfortunately, the concept of the "crash" is so ingrained in the fear mechanism of investors that the word is thrown around with little or no meaning anymore. After all, what is a crash? Has the SEC or NASD ever set out to define exactly what constitutes a crash? How does a crash differ from your typical vanilla flavored decline? To illustrate what is meant by a crash, let's quote from the Washington Post on the day after the 1987 decline:

The stock market was devastated by the worst one-day collapse in history yesterday in a pandemonium of panic selling that shattered all records and swamped stock exchanges around the country and overseas.... John Phelan, chairman of the New York Stock Exchange, called the collapse a near "meltdown" caused by a "confluence" of factors: the market's inevitable turnaround after its long climb, heightened anxieties over rising interest rates and future inflation, and the impact of computerized trading maneuvers.

--Washington Post, October 20, 1987

Words like "devastation," "pandemonium," and "meltdown," especially coming out of the mouth of the chairman of the NYSE, should give you an indication of what's involved in a "crash." It isn't pretty and it doesn't happen often. You see, our language has words to describe various degrees of goodness and badness. "Crash" is really bad and happens once every several generations, if at all. In the past 100 years, we've had two such events. That's about 28,000 trading days, and two of them are called "crashes." Why then do we constantly contemplate the next debacle? I suppose part of the answer lies in the fact that using exaggeration helps us to cope. I also think that we tend to concentrate all of our collective effort understanding the incredibly rare occurrence and doing very little to adhere to the obvious and often occurrence. After all, "10,000 planes landed safely today" isn't much of a headline, is it? I imagine that it's instructive to understand what causes horrible events so that we may not repeat them, but if I had to choose between understanding what happens twice a century and what happens every day, I'd chose the latter.

The reality is that the market generally rises. On average, the market goes up 10-12% a year. It's normal for this to happen because the economy grows and profits rise. Profits rise in strong companies and weak companies get parsed out of the picture in a Darwinian fog of natural selection. New companies then start up and have the audacity to believe that they can compete against the Intel's, Googles and Microsofts of the world. The beauty is that some actually do, and the entire landscape of our capitalist society becomes stronger for it and we continue to grow.

Will we "crash" tomorrow? The next day? I have no idea and I don't really care. Given that I don't have a crystal ball and couldn't predict it anyway, there isn't much I'd be able to do about it. All I can do is manage my risk by constantly evaluating the attractiveness of the stocks I own. That's where the education comes in, the hard work and the satisfaction. So, if I could give any advice, it would be to do your homework, go forward with a belief in our capitalist society, stay invested, and stop worrying about when the next darn Crash is going to happen.

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