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Stock Industry Plunge

On Could 14, 2010 the US stock industry plunged strongly down by beating all historical records. The DOW Jones Industrials, S&P 500 and other indexes suffered huge losses. Some public companies went down to pennies from $30 and higher. Later, media explained this event as a computer error, then as a human error, than the media announced that exchanges started to investigate this drop down and later everybody forgot about these unusual incidents penny stock.

When trying to understand events of the plunge it is recommended referring to the basics principles of the stock marketplace price movements. The first and the most basic rule of the stock market is that price is driven by supply and demand. If a trader (investor) must sell a stock he or she sells it at market place price. Now, if a trader must to sell 10,000 (ten thousands) shares of a public company he has to find a buyer who would buy these ten thousand shares. If there is not enough buyers to cover demand to sell ten thousand shares then the price of this stock goes down until there are enough buyers to buy these shares. Of course, the stock market place operates by billions and 10K is relatively small number which does not greatly affect price of a stock.

The second point that has to be cleared is that there could be two situations: fist is when a trader wants to sell stocks and second when a trader must to sell. In first case, if price goes rapidly down (plunges) an investor may perhaps change his/her mind and make a decision not to sell but wait when the traded stock recovers. Second case usually occurs when a stop-loss is hit or when a trader has received a final margin call. Whether it is a stop-loss or margin call it is not a trader who places an order to sell but a broker and in this case a position must to be eliminated (closed) at any possible market price.

Now, coming back to Could 14, 2010 you may perhaps try to imagine that during the stock marketplace decline big number of stop-losses was hit. I am not looking at situation with margin calls because in this case, as a rule, there are several days until margin is executed. When stop-losses are hit, brokers place orders to sell at market place price. Now, because of an error in computer, or because of human error, as was only once mentioned in CNN "operator entered B (Billions) instead of K (thousands)", or by any other reason there were placed orders to sell billions of shares. Since there were no buyers for such big volume of stocks, price plunged down. One huge drop in one stock may possibly generate chain reaction. If this stock is listed in the indexes (S&P 500, DJI, Nasdaq 100, etc) then this stock's decline drags the indexes down, then other stocks starts to follow the indexes and then new stop-losses are hit and more sell orders are placed on the market place and then all repeats again and again and it accelerates into the crash.

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