Why Stock Market Crash: After the huge 30% stock market crash of COVID, a topic that has got many interested and worried is about stock market crashes. Most of us have lived through at least 2 crashes the other being the 2008 financial crisis.
But this interest is not only because of curiosity but also to protect oneself from these crashes. In this article, we take a look at when and why stock markets crash and also how to protect yourself from one. Keep Reading to find out!
Table of Contents
What is a Stock Market Crash?
A stock market crash refers to a rapid fall in the country’s stock market index in a single day or over a few days. There is however no one specific number that can describe a stock market crash but is generally called a crash when the index like Sensex or Nifty falls by a double-digit percentage in a short period of time.
This however should not be confused with a stock market correction. This is because the stock market crash is a lot more quickly. Another term that some may confuse a stock market crash is a bear market. A stock market crash may bring forward a bearish market but the two are different.
A crash as mentioned earlier happens in a matter of days or weeks. A bearish market on the other hand remains over months or even years. In a bear market, the stock market falls by at least 20% from its peak over a period of time.
Another follow-up characteristic of a stock market crash is that investors enter a state of panic and look to sell their stock as soon as possible. This is done in order to avoid further losses. But this only further hammers the market down.
Some examples of stock market crashes in the Indian stock market are during COVID-19, the 2008 financial crisis and post the Harshad Mehta scam. As seen in these cases the stock market crashes also have severe consequences in a country’s economy.
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What are the Causes of a Stock Market Crash? When Does a Stock Market Crash?
Stock market crashes are generally triggered by negative events that may affect the economy. These are generally amplified when the market has experienced a bull market for a prolonged period of time. This leads to investors selling off their investments. Now let us take a look at some of the negative events that may trigger such as
1. Natural Calamities
These are the reasons why crashes are known to be unpredictable. These can include earthquakes, tsunamis, etc that have a widespread impact on the country’s economy. One of the most recent effects and best example of a stock market crash, in this case, is the COVID-19 pandemic.
The fear of the effects that a pandemic will have on the country’s economy led to the stock market falling by over 30%. Natural calamities however are not the only causes. There also exist a lot of unforeseen man-made events that may cause a stock market crash.
2. Economic Crisis
Economists and unbiased seasoned investors generally see signs of this coming from miles away. One of the best examples of this is the American mortgage crisis of 2008. The ailing banking sector finally gave in leading to a stock market crash of 2008
3. Speculation and Panic Selling
Generally, in long periods of bullish markets, a lot of trades are done on speculation. Investors generally have high expectations from the market as they have observed the bullish market for a period of time. But pumping money into the market based on these expectations leads to an overinflated price scenario called a bubble.
Over time the markets generally fail to meet the high expectation of the investors. This in turn leads finally to the bubble being burst. This in turn leads to panic selling in a desperate move by the investors to protect their investments. This further worsens the scenario leading to a crash.
How Can One Identify a Stock Market Crash?
One of the best quotes that individuals can refer to in times of doubt is given by Joseph Kennedy. “If shoeshine boys are giving stock tips, then it’s time to get out of the market.” As the story goes at a time when the American markets were at an all-time high the stock market craze had caught onto most individuals.
As Kennedy stopped to get his shoe shined even the shoeshine boy started giving him stock tips. This was when he realized the quality of knowledge with which investing was done and funds that were being pumped into the stock market. This allowed him to realize that the stock market had entered a bubble.
Generally when one hears an urgency to invest in stocks right now or miss out on a big opportunity is a time to take a deep breath. It is here when the markets are driven by emotions rather than a deep analysis of the financials. If your investments are made based on the latter for the long term then there is very little that you need to worry about!
What Should You do to Protect Yourself Before and During a Stock Market Crash?
As we have seen above there are no concrete steps that an individual investor can take to identify stock market crashes. Individuals cannot predict calamities but at times they can identify bubbles or when the economy is particularly performing poorly but the stock market is still bullish. Regardless here are some steps that an individual can take to best protect his investments
1. Do Not Give in to the Pressure to Sell Instead Buy if Possible
Generally, in cases of stock market crashes, investors enter into a state of panic. Here they begin selling their holdings in an attempt to protect themselves from further losses but often do so at a great loss already.
One aspect of the stock market crashed is that investors must keep in mind is that markets rebound back to their original state (not as quick as the crash). So if an investor has already invested in quality stocks after analysis for the long term he should stay put and not follow the crowd.
Take for example an investor who enters the market at a share price of Rs. 80. His investments touch a height of Rs. 100, During a crash his investments may fall to Rs. 60 but by following the crowd the investor may incur a loss of 25% or even worse. Staying put and believing in his research is the best strategy in this period.
A famous investing quote by Baron Rothschild goes,” the time to buy is when there’s blood in the streets.” In this case, it means that during a stock market crash while most investors are selling one must look for opportunity.
Several quality stocks are available at highly discounted rates. Hence one must take advantage of this scenario while others panic and take on losses.
2. Always Have a Diversified Portfolio and Rebalance to Suit the Market
It is always advised to have a diversified portfolio. But this diversification should not stop at stocks. Investors must also make use of all instruments like bonds, gold, silver, etc to further protect themselves. This will further help reduce the impact that an investor faces in a crash.
Also, it is important that the investor adapts to the needs of the market. It is generally noticed that the prices of gold increase when the stock market performs poorly. Taking note of this it is best to go ahead rebalance your portfolio as per the situation.
3. Always Have a Safety Nest
It goes without saying that never put 100% of your savings into the stock market. It is important to always have a nest put away in other means like liquid cash, land, etc to protect yourself from a rainy day.
At the end of the day, it is important to remember the saying that has already been drilled into our heads. “ Stock market investments are subject to market risk!”
In Closing
At the end of the day, no one can perfectly predict each and every stock market crash. This is one instance where it clearly helps to stay calm or just be a long-term investor. If you are one with quality researched investments you have very little to worry about.
Although you will also feel the pinch of the fall in your portfolio the markets are known to rebound in a matter of time often to new heights. That’s all for this post let us know what you think about this article and also share your experience in the comments below. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
