What can Cause a Market Crash? Here are the Top Reasons

Market hype reached a plateau: Regardless of how fantastic and disruptive a particular company or crypto market is, it is inevitable that they will eventually fall victim to market hype. But the thing is, you can only reach so many people. Plus, no force is perpetually active and untangible. These factors combined cause a plateau - described as a state of little to no change after a long period of intense activity. As fewer people are raving about the ecosystem, more are inclined to sell. Eventually, a mass sell-off is inevitably engaged and thus, the crash.

Overlevaraging: People who got their positions liquidated by overleveraging their trades, an all-too-common practice in intense bull markets that can cause a domino effect of market depreciation. Expecting the market to keep rising as it has during a bull run, investors may borrow against the investing platform to use, ten, twenty, or sometimes a hundred times more than they actually have in funds. Once the market tumbles, even if so slightly, the unexpected happens; the asset is now at a much lower value for the leverage to cover, and an immediate mass liquidation occurs.

Institutional crackdown: While large investors such as companies, financial firms or funds become concerned about the mid to long-term prospect of the assets, news of influential institutions turnings their backs on crypto cause an immediate effect on “retail” investors. A great example of this is China banning crypto mining back in May 2021, contributing to the crypto ecosystem losing more than 50% of the total market cap in a month.

Higher interest rates: Higher interest rates generally mean a higher cost of borrowing funds at both retail and sophisticated-investor level, which demotivates the market into pursuing more assets to stock up their portfolios. That effect happens across the board, whether is in stocks, crypto, bonds, the housing market, you name it. Basically, if it costs more money to invest then people tend to engage less which cools down the markets.

Fear and panic: What really brings markets from uncertainty and concerning volatility to an outrightly clear market crash is always panic. Regardless of market hype, overleveraging, institutional crackdown, high-interest rates and more, it can only truly become a market crash when millions of people across the world think the market has reached a point of no return and must sell their assets - immediately.


Pretty much every investor who has had more than a year of experience has gone through this situation; your investments are going well and the markets seem to be flashing green all across the board. You are enjoying your portfolio and wake up every morning to values constantly appreciating, and it’s not even surprising anymore.

Suddenly, a correction - followed by a major crash. What could have happened, if everything was going so well and investors were all so very positive about the market?

Turns out, market corrections and even crashes are completely normal, and many would say healthy for the financial spheres. In this article, we cover the top reasons why markets crash to provide a glimpse of why these situations are unpredictable and, in the long run, quite irrelevant.


Market hype reached a plateau

---

Regardless of how fantastic and disruptive a particular company or crypto market is, it is inevitable that they will eventually fall victim to market hype. Much like new movies that seem to become extremely popular out of the blue, crypto markets and others as a whole are also vulnerable to the powerful financial variable called “word-of-mouth.” One person invests in promisingly ambitious crypto and tells their friend, who invests and tells other friends, and so forth.

We have seen that scenario several times in crypto over the past few years; right before a major market correction, things couldn’t have seemed brighter as new investors and people interested shared their excitement online and in their social circles. Crypto, a particular stock, what have you, is the talk of the global financial sphere.

But the thing is, you can only reach so many people. Plus, no force is perpetually active and untangible. These factors combined cause a plateau - described as a state of little to no change after a long period of intense activity. Regardless of how great the crypto market or the stock market is, with raving new technology and innovation entering exchanges, these factors combined cascade into their lightest holders and casual investors losing excitement. As fewer people are raving about the ecosystem, more are inclined to sell. Eventually, a mass sell-off is inevitably engaged and thus, the crash.

But hype doesn’t do enough damage in-off itself. The main issue of market hype comes from what investors choose to do once they’re extremely confident about the market. When the graphs have been showing green for too long, it leads the optimistic masses to make drastic decisions, and the most dangerous one is trading with high leverages.


Overleveraging

---

The crypto slang “get rekt” (get wrecked) references people who got their positions liquidated by overleveraging their trades, an all-too-common practice in intense bull markets that can cause a domino effect of market depreciation. Overleveraging occurs when investors create positions seeking unprecedented amounts of profit that are too large for them to afford. Expecting the market to keep rising as it has during a bull run, investors may borrow against the investing platform to use, ten, twenty, or sometimes a hundred times more than they actually have in funds.

Once the market tumbles, even if so slightly, the unexpected happens; the asset is now at a much lower value for the leverage to cover, and an immediate mass liquidation occurs. Those who overleverage saw their funds going from any amount to literally zero in a matter of hours or even minutes. The cascading event arrives; overleverage liquidates positions, liquidations cause the asset to depreciate, and fear takes over the general sentiment.


Institutional crackdown

---

Perhaps the most straightforward reason for a market crash or market correction, an institutional crackdown on cryptocurrencies or other assets always leads to uncertainty for other investors in many ways. While large investors such as companies, financial firms or funds become concerned about the mid to long-term prospect of the assets, news of influential institutions turnings their backs on crypto cause an immediate effect on “retail” investors - non-professional investors who have not made a career out of financial roles.

There is no greater example of a recent institutional crypto crackdown that reshaped the markets to a complete downside trend than a year ago, in May 2021. China, at the time the largest source of Bitcoin mining in the country, organized a complete crackdown against miners in the country, shutting down hundreds if not thousands of mining centers while also banning all forms of cryptocurrencies. Combined with great hype from the past few months which can only lead to over-leveraged investors, the final trend shifter was Elon Musk announcing that Tesla - at the time crypto’s favorite company with its dogecoin-lover leader - would no longer be accepting Bitcoin as a form of payment. In just a couple of months, Bitcoin went from its then all-time high of $63k dollars to $29k.


Higher interest rates

---

Earlier in 2022, the Federal Reserve began its process of rising interest rates in an effort to tamper with the rapid inflation that’s ravaging the US (and the world). With its recent May announcement bumping the rate hikes from 25 to 50 basis points, it seems like we are only seeing the beginning of higher interest rates in the country - one with the most influential stock and crypto market in the world.

So how can higher interest rates cause a market crash? Higher interest rates generally mean a higher cost of borrowing funds at both retail and sophisticated-investor level, which demotivates the market into pursuing more assets to stock up their portfolios. That effect happens across the board, whether is in stocks, crypto, bonds, or the housing market, you name it. Basically, if it costs more money to invest then people tend to engage less which cools down the markets. If higher interest rates are announced during a major bull run, it can cause a massive market correction or even a crash.


Fear and panic

---

Market crashes and corrections aren’t caused by a single factor; it is always a combination of several events, both macro and micro, and unprecedented scenarios that contribute to a sudden downside in any market. However, what really brings markets from uncertainty and concerning volatility to an outrightly clear market crash is always panic.

Regardless of market hype, overleveraging, institutional crackdown, high-interest rates and more, it can only truly become a market crash when millions of people across the world think the market has reached a point of no return and must sell their assets - immediately.

Although there’s not a clear path to combating this, since it relies on the will of the millions in masses, the best individual path would be to pause and reassess. Is there truly a reason for panic, or is everyone following the same “hearsay” pattern? Will the projects behind my stocks and cryptos be affected in any way if the markets are not going well, or will they continue to produce as expected? And of course, remember Ken Fisher’s timeless proverb: “time in the market” beats “timing the market”.



Author: Gate.io Researcher: Victor Bastos
* This article represents only the views of the researcher and does not constitute any investment suggestions.
*Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all other cases, legal action will be taken due to copyright infringement.