The reduction in speculative trading is considered the main reason for the current slump in the Japanese stock market. (Source: CDN)

Specifically, the Topix index fell sharply by 13% in its worst trading session since 1987. The index is now nearly 25% lower than its peak reached just a month ago.

The Nikkei closed down 12.4% to 31,458.42 points. In percentage terms, it was the second-biggest drop since the “Black Monday” crash in October 1987, when the index lost 3,836.48 points, or 14.9%.

Meanwhile, the yen is recovering strongly, up 12% from less than a month ago, when the currency was at a 37-year low.

These market turbulences reflect changes in monetary policy. Over the past 18 months, the yen has fallen sharply as the US Federal Reserve (Fed) has raised interest rates, while the Bank of Japan (BoJ) has been on the sidelines.

At that time, the carry trade, where investors borrow cheaply in Yen to make higher-yielding investments in USD or Euro, flourished, causing the Yen to weaken further.

The weak yen has boosted Japanese companies' overseas profits and attracted foreign investors to the Japanese stock market. Foreign investors bought a net 9 trillion yen ($60 billion) of Japanese stocks in 2023 and the first half of 2024.

But now things are reversing. The BoJ has taken small steps to tighten policy. On July 31, it raised interest rates from around 0.1% to around 0.25%. In contrast, the Fed is expected to start cutting rates soon.

Those expectations were boosted on August 2 after the US jobs report showed the economy added just 114,000 jobs in July, below the 175,000 expected by investors.

The yen strengthened to 141 yen per dollar, its strongest level in seven months. The currency had risen from 148 yen per dollar to 146 yen per dollar in New York trading on August 2, after the US released a "weaker" July jobs report that raised concerns about a possible recession.

The soaring yen has fueled the stock market crash. Japanese exporters have traditionally benefited from the yen's weakness because they generate most of their revenue overseas but report their earnings in yen.

Now, those companies are in trouble. In the stock market, margin trading—trades made with borrowed money—hit its highest level since 2006 before the sell-off. These leveraged investments are now being cut back rapidly.

That's why previously popular stocks are taking the biggest hits.

Shares of Tokyo Electron, a key semiconductor equipment supplier, fell 18% in the August 5 session.

Shares of Japan’s major banks all fell, with Mizuho Financial Group down 19.7 percent, Mitsubishi UFJ Financial Group down 17.8 percent, Resona Holdings down 19.5 percent and Sumitomo Mitsui Financial Group down 15.5 percent. Regional banks were no exception, with Chiba Bank down 23.7 percent and Fukuoka Financial Group down 17.9 percent, while brokerage giant Nomura Holdings fell 18.6 percent.

Currently, the reduction of speculative transactions as above is considered the main cause of this plunge in the Japanese stock market.

Almost no experts believe that Japanese companies are in serious trouble, or are concerned about the stability of the country's financial system.

Sharing the same view, veteran strategist at Nomura Securities - Mr. Naka Matsuzawa commented: "Foreign investors are selling Japanese stocks, due to concerns that the US may be heading towards recession, not necessarily due to specific Japanese reasons."