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Why Stock Markets Crash

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Why Stock Markets Crash

Critical Events in Complex Financial Systems

Princeton UP,

15 min read
10 take-aways
Audio & text

What's inside?

Can you read the tea leaves that portend a crash? Just try applying science to the behavior of financial markets.

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Editorial Rating

7

Qualities

  • Comprehensive
  • Analytical
  • Innovative

Recommendation

The word crash strikes fear into any investor’s heart. Fear not, writes scientist Didier Sornette, who has crunched the numbers (not to mention the probabilities and log periodicities) and has determined that crashes are, in fact, quite normal and predictable. If prices are soaring and everyone you know says profits are guaranteed, get ready. Sornette backs up his argument with countless charts, formulas and phrases such as "spontaneous symmetry-breaking regime." Still, there’s enough plain English here to enlighten the lay reader. getAbstract suggests this book to traders and investors looking for a unique analysis of market crashes.

Summary

New Thinking about Market Crashes

Government officials, traders and investors widely fear market crashes, yet explanations of how past crashes occurred almost always are flawed by simplistic thinking. Conventional wisdom says short-term events, such as external shocks or revelations of key information, trigger crashes. People perceive these apparent causes as sudden and unpredictable. In fact, outside events are less of a factor in crashes than people widely believe. Crashes occur because of market instability that reaches the breaking point after years of accumulated events.

By the time a market reaches the point of a crash, any otherwise tiny event can lead to a collapse. Consider the October 1987 Wall Street crash. Analysts typically blame it on five factors:

  1. Program trading – Because it exacerbated selling.
  2. Derivatives – Because they increased volatility.
  3. Illiquidity – Because many sell orders were not executed.
  4. Trade and budget deficits – Because of their impact.
  5. Overvaluation of stocks – Because value had run-up in the previous two...

About the Author

Didier Sornette is professor of geophysics at the University of California, Los Angeles, and a research director at the Centre National de la Recherche Scientifique in France. Sornette specializes in scientifically predicting catastrophes in complex systems. He is the author of the textbook Critical Phenomena in Natural Sciences.

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