Stock Prices Declining Suddenly Across the Board

• A stock market crash is foreseeable if stocks drop in value virtually overnight. Even as the stock market can weather a few companies' stock losing value---or even a certain segment of industry failing---an unexpected loss of a variety of stocks from various kinds of companies leads to a consumer behavior-fueled panic. Individual investors will attempt to sell off their stocks to protect their investment portfolios from certain loss. It is hard to discern whether consumer behavior causes the stock market crash or simply fuels it. But once an unexpected, widespread stock price loss is noted, subsequent consumer behavior is inevitable and the stock market crash is almost unavoidable.
  
  

Banks Left Insolvent

• The 2008 market chaos is a good example of bank failures precipitating stock market crashes. Banks extended mortgage loans to groups of consumers who were predictably unable to make their monthly payments. The banks then traded the mortgage papers back and forth, in some cases actually selling off only portions of the mortgage loans and bundling them with other mortgage loan portions. Before long, there was no tangible asset that changed hands, only the promise of paper. When the mortgages went bad, banks were unable to rely on the incoming capital to remain solvent. The insurance companies that indemnified these transactions were called to task, and subsequently they also became insolvent. Bank failures were inevitable and led to many investors losing their portfolio since some bank stocks were now worthless, as was the case with Washington Mutual. Before long, in cases like this, panic ensues and there is a subsequent run on the market as investors try to sell off as many stocks as possible. The end result is a stock market crash. Business Week (see Resources below) offers insight into the 2008 stock market crash.
  
  

The Problem With Amateur Investors

• If large groups of investors have margin accounts that fall short of the minimum margin requirement, a margin call will cause them to either supply the funds to increase the margin as stated or cash out. If enough investors opt for cashing out, the market will register a sudden influx of sell orders that will not remain unnoticed by other investors unaffected by the margin call. Before long, consumer behavior will once again play a crucial role in determining the shape of the stock market, and an additional increase in sell orders will cause stock prices to drop dramatically, leading toward a crash. The problem here lies in that casual or amateur investors do not understand many of the stock investment intricacies. Rather than recognizing margin calls for what they are, individuals are fearful that other investors are seeing a problem on the horizon of which they are not aware. Thus, it appears as though it is safer to sell at a loss than hold on to stocks that might be worthless tomorrow.