The market is crashing, and everyone is storming Google to ask why.  Well, if you bought GameStop at $200 per share or are still clinging to Dogecoin praying to Elon that he tweets about it so you’re not as negative as you are now, it’s going to be hard to explain.

For those of you who did not fall for the hype, it’s worth mentioning that catching a falling knife is never a good idea.  That is, unless you study this stuff and can see through the news.  

Let’s dive into the shallow end.

Why Is The Market Crashing?

You know the old saying that markets crash when a lot of people are wrong all at once?  Well, that’s exactly what’s happening.  Market moves like this only happen when many big accounts (think hedge funds) receive what’s called a margin call. 

If you know what that is and just got chills, that’s the correct response for small accounts.

There was an assumption in the market, which we’ll get to, that suddenly flipped profitable positions into unprofitable territory.  At that moment, a lot of HUGE accounts started selling out of their positions.

The size of these accounts means that it takes some time to sell out of their positions, so the mass selling was forcing margin calls before they could sell at prices they wanted.  Then, when they couldn’t cover the margin call, that’s when the positions are force-sold by the brokers.  That’s when the selling went bananas, and here we are.

It’s worth mentioning that algorithms only make the problem worse.  They’re getting better, but huge selling typically triggers algorithmic trading funds to sell.  It’s usually a fail-safe to protect accounts from black swan moves.  Some programs will even do double damage on selling.  This means they sell out if long positions while simultaneously putting on short positions.

Back to that assumption I mentioned.  You’re probably wondering what it was.  Economic professors and the like would call it a “catalyst.”  This catalyst was the Bank of Japan, the Japanese counterpart to the US Federal Reserve, raising their interest rates.

Why Would the Bank of Japan Affect US Markets

Big players in the financial markets like to pay interest in order to use other people’s money to fund their investments.  I say “like to,” but really they pay it out of spite, and half of all finance is figuring out how to execute on an investment opportunity more cheaply than the next guy.

In this case, the investment was currency.  The strategy is called a carry trade.  This involves borrowing in a low cost currency, the Japanese Yen in this case, and using it to fund purchase of an investment in a higher-cost currency, like the Euro.

The big players all have Japanese offices, and they would borrow trillions in Yen at very-low single-digit interest rates.  Then, they convert that in the foreign exchange markets to do business in other countries.  It’s a bit more complicated, but that’s the gist of it.

Imagine if you knew you could take out a mortgage at 2% interest in Japan while every bank in the US is charging you 7%.

Will The Crash Stop Soon?

Probably not, but most of the damage has been done.  Things like this come from panic selling.  It stemmed from the fact that few believed the BoJ would raise their rates like this.  Now that the board is set and there is a better understanding of what banks are going to do, any selling is going to be more organized and less panicky.

What you’re likely going to see is several bounces – yes, some of them may push deeper than the recent lows – but there’s nothing on the radar that should cause a huge,  sustained bear market.  That is, unless you count crippling government debt.

Don’t sell out of all your stocks just yet.  A correction nearly always comes around interest rate changes that are expected to some extent.  With volatility coming back, I would stay away from short-term, high-risk investments until the dust settles.