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Market disruptions, such as crashes and inflationary bubbles, can destabilize security prices and limit access to credit. Regulatory authorities use various means to prevent disruptions, but predicting them can be challenging. Corrective measures may include limiting trade or temporarily shutting down markets.
A market disruption is a major event that interrupts regular trading and other financial activities. It can occur over the course of one or several days, destabilizing security prices, limiting access to credit, and interfering with ordinary market business. Regulatory authorities use a variety of means to prevent market disruptions while facilitating free and open trade. In the event of a problem, they may choose to conduct an investigation to learn more about what happened, what led up to it, and how to prevent problems of a similar nature in the future.
Crashes are a classic example of a market disruption. They can be precipitated by a variety of triggers that lead investors to start selling securities as quickly as possible. Investors believe that the value of their securities may decline and wish to exit vulnerable trading positions. In the process, they can accelerate falling stock prices by creating panic, leading to a wave of selling activity that drags stock prices down very quickly.
Inflationary bubbles are also a form of market disruption. In this situation, the prices of securities, commodities, or other assets rise well beyond fair market value in a short period of time. High trading activity tends to facilitate this, pushing prices up as people seek to position themselves in a suddenly crowded market. One problem with bubbles is the possibility of a correction, where prices will fall back to a more reasonable level, taking traders with them.
Within the financial industry, a market disruption can be a major cause for concern. Banks, for example, rely on easy access to credit through interbank lending to finance their operations, extend credit to customers, and engage in other market activities. If they suddenly cannot access credit, or cannot locate credit at reasonable interest rates, they may experience business interruptions, and could risk failure altogether if the market disruption is not corrected in time. Some banks may activate what are known as market disruption clauses in contracts with trading partners if they feel they need to terminate a contract due to problems with the market.
Predicting the course of markets can be challenging, though traders, regulators, and analysts certainly try. Warning signs that a market disruption is on the horizon may include a market that appears to be weakening, political situations that are changing, or traders behaving abnormally. Corrective measures to address a potential disruption may include limiting trade if prices rise or fall too fast, or temporarily shutting down markets entirely to prevent catastrophe.
Smart Assets.
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