A market crash is when a market (or group of markets such as the stock indicies) makes a larger than normal, and quicker than normal move downwards, as a result of uncontrolled selling (or panic selling). It is commonly believed that any significant move downwards is a crash, but this is incorrect. The uncontrolled selling must be present in order for the move downwards to be a market crash.
Uncontrolled selling differs from controlled selling (or regular selling) in two significant ways that contribute to the move downwards. Firstly, uncontrolled selling consists of mostly market orders as opposed to limit orders. Traders use market orders when they want to exit a trade regardless of the current price (i.e. when they panic). Secondly, uncontrolled selling includes a large number of stop loss orders. Stop loss orders are used to exit a losing trade, and are usually also market orders, thereby contributing to the uncontrolled selling.
Short trades (also know as short selling) are often blamed for market crashes, but this is misplaced blame that comes from not understanding how market dynamics work. Short trades actually provide stability to a market, and can slow down or even prevent a market crash. Short trades are entered by selling and exited by buying. This means that when most traders are panic selling (and causing the crash), the short traders are buying (to exit their trades and take their profit). This buying provides balance to the selling, which causes the crash to lose momentum and possibly even reverse.
