The mechanics of a crash: Selling because you must, not because you want to

A crash is not just a panicking crowd. It is also a selling machine, with precise gears.

First gear: buying on margin. You buy shares with your own money, plus money lent by your broker.

Say ten thousand euros of shares: five thousand yours, five thousand borrowed. If they rise twenty per cent, you gain forty per cent.

But the effect works both ways. If they fall twenty per cent, you lose forty per cent of your money.

The broker sets a rule. For the example: your share must stay at least a quarter of the portfolio's value.

Here, the rule breaks as soon as the shares lose a third. The broker calls you: put in money, or he sells for you.

That is the margin call. You do not sell because you want to. You sell because you must.

And you sell at the worst moment: when prices are already low, and others are selling too.

Second gear: the liquidity spiral. Thousands of investors get the same call, on the same day.

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They sell. Prices fall. The fall triggers new margin calls, which force new sales.

Buyers step aside. The door narrows just as everyone wants to get out.

Third gear, the one from nineteen eighty-seven: portfolio insurance.

The idea, born in the early eighties, seemed brilliant: automatically sell a little more with each fall, to limit the loss.

For a single investor, it is prudent. But in nineteen eighty-seven, tens of billions of dollars were managed this way.

The market falls, the programs sell. These sales push the market down, and the programs sell again.

After the crash, an American inquiry commission named these programmed sales as a major accelerator of the fall.

The lesson: protection that works for one person can become a danger when everyone uses it.

Fourth gear, the response: the circuit breaker. If the market falls too fast, everything stops for a while.

In the United States today, a seven per cent fall halts trading for fifteen minutes. At thirteen per cent, another fifteen minutes.

At twenty per cent, the market closes for the day. In Europe, each share also has its own halt thresholds. These rules can change.

The aim is not to stop the fall. It is to give everyone time to breathe, and buyers time to come back.

Debt, the spiral, the programs, and the brake. In almost every crash, you find at least one of the first three.

For you, the simplest protection is not a program. It is never being the one who must sell: no debt to buy shares.