What is a Stock Market Crash?

Let us discuss what a stock market crash is.

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Introduction

A stock market crash occurs when stock prices fall suddenly, unexpectedly, and significantly. The collapse is frequently precipitated by a single cataclysmic event that kicks off a chain reaction of minor catastrophes.

Stock Market Crash Explained

A stock market crash occurs when investors sell their stocks in a hurry, resulting in a significant decline in stock value. As a result, the value of stocks plummets, prompting other shareholders to sell their stock in an attempt to mitigate their losses. As a result, investors may lose a significant portion of their funds.

Indexes such as the S&P 500, the Dow Jones Industrial Average (DJIA), and the Nasdaq help us comprehend how well the stock market is (or isn’t) performing. You can understand why we use the phrase crash if you look at a historical graph of one of these indices. It’s like seeing an aircraft go downhill.

Stock Market Crashes in History

Markets have experienced many severe ups and downs throughout history. Looking back, we can see that while a market meltdown is a horrible experience, it is one that we can and will recover from. 

• The Great Depression, 1929: The DJIA fell about 25% in only a few days.3 It took the economy nearly a decade to recover to pre-depression levels. The post-World War II industry was essential in reviving the economy.
• The 1987 Stock Market Crash: The market lost 22.6 percent of its value in one day, dubbed “Black Monday,” yet it regained everything within two years.
• September 11, 2001: Terrorist attacks in the United States resulted to a significant drop in the stock market, which quickly recovered. Only one month later, the stock market had rebounded to its September 10 highs and continued to rise until the end of 2001.
• Great Recession of 2008: The DJIA lost more than half of its value in a very short period of time. However, within a few years, the market was stronger than it had ever been. From 2009 until right before the coronavirus crisis, we were essentially in a bull market (a time of rapid economic development).
• The 2020 Coronavirus Crash: In March 2020, the COVID-19 epidemic produced the most rapid global financial crash in history. Nonetheless, the stock market quickly rebounded, and the year ended with record highs.

So keep your head held high. You’ve probably already been through at least two big collapses and recessions. It’s all part of the cycle of life!

How the 2020 Coronavirus Crash Affected the Stock Market

Let’s imagine we had a time machine that will transport us back to March 2020, when the coronavirus was officially designated a pandemic (don’t worry, we won’t be there long). The global economy was in shambles as people binge-watched Netflix series or flocked to the stores to buy toilet paper. The supply chain came to a screeching halt. Throughout the night, whole industries were shut down. And the stock market crashed—significantly.

The stock market took us all for a ride during the early days of the pandemic. Global markets (not only in the United States) plummeted, initiating a brief bear market (when the stock market crashes by at least 20 percent) and an economic recession in the next months. If you were monitoring your 401(k) at the time, you were undoubtedly terrified as you saw your funds vanish.

However, following the initial plunge in March, the market began to slowly recover. By the time the New Year’s Eve ball dropped on December 31, 2020, the stock market had recovered all of its lost ground—and then some! Did you hear what I said? In 2020, all main indicators increased:

• The S&P 500 increased by 15.6%.
• The Nasdaq rose by 43.8%.
• The Dow Jones Industrial Average increased by 6.5%.

Even the massive, terrifying coronavirus crash didn’t knock us out for long, as we can see. In fact, analysts today claim that the coronavirus-related recession was the shortest in history, lasting barely two months!

Causes of a Stock Market Crash

A stock market crash can be caused by a variety of circumstances. Investors sometimes discuss a bubble bursting after a key event causes a selloff. This might be due to economic issues such as:

• A prolonged period of stock price increase accompanied by excessive economic optimism, resulting in reckless conduct that finally reverses.
• P/E ratios and other valuation indicators outperform long-term averages.
• A market that is highly leveraged.

On the other hand, a stock market crash can also be driven by two major factors:

• A sharp decline in stock values; and
• Widespread fear.

Here’s how it works: Stocks are small shares of a firm, and investors who buy them earn when the stock’s value rises. The worth and price of such stocks are determined by how well investors feel the firm will perform. As a result, if they believe the firm in which they have invested is in trouble, they sell the shares in an attempt to get out before the value declines.

The truth is that fear plays just as big a part in a stock market crash as the underlying economic difficulties.

Let us look at an example from the coronavirus pandemic to demonstrate the power of terror. As word of the illness spread, supermarket and convenience stores throughout the world quickly ran out of toilet paper. Was there a scarcity of toilet paper? Yes and no, to be sure. Before people started worried, there wasn’t a scarcity. However, when people went insane and began stockpiling toilet paper, they caused a scarcity!

A stock market crash can be precipitated by the same type of fear. When they observe other investors selling their stocks, investors become quite concerned. The stock market then begins to fall in value, prompting more investors to liquidate their holdings. Then, all of a sudden, everyone is selling their stocks, and the market is in full-fledged panic mode. Keep an eye out for what’s down there!

Our thesis is that the stock market’s value is entirely determined by perception and forecasting of the future. It’s no surprise that it feels like a roller coaster!

Is a Stock Market Crash Indicative of a Recession?

A stock market meltdown may trigger a recession. A recession may arise if the market causes larger economic concerns. A recession is often defined as a two-quarter decline in GDP.

What is the Difference Between a Stock Market Crash and a Market Correction?

Corrections are less severe and last less time than crashes. A correction usually lasts a few days, weeks, or months and results in a 10% drop in market value. Stock market crashes often result in a 10% reduction in value in a single day and continue to plummet for months, if not years.

Can Money be Lost if the Stock Market Crashes?

If the stock market crashes, the value of your portfolio will fall. If you sell your holdings, you will lose money. Investors who bought stocks on margin may potentially suffer margin calls and be compelled to liquidate at a loss.

How Long Can a Stock Market Crash Last?

Stock market crashes can be brief or long-lasting, depending on whether the economy is in a recession or depression. Typically, a crash lasts 11 to 23 months. However, the market might take up to five years to recover and return to regular trading circumstances.

During a crash, it is impossible to determine the market’s bottom. Investors may choose to acquire and hold excellent firms they believe in for the long term, or they may chose to invest a portion of their investment cash at regular intervals throughout time.

Tips on How to Protect Your Money from a Stock Market Crash

To prevent fear-based selling from inflicting more market damage, the New York Stock Exchange (NYSE) includes market decline triggers that can suspend trading if prices fall too much in a single trading session. The following are the three triggers:

• Level 1: Trading is suspended for 15 minutes if the market declines 7% in a single trading session before 3:25 p.m. EST
• Level 2: Trading is suspended for 15 minutes if the market falls 13% in a single trading session before 3:25 p.m. EST
• Level 3: Trading is suspended for the duration of the trading session if the market falls 20% at any point during the session.

To Buy or To Sell During a Stock Market Crash

During a stock market crisis, there is typically a lot of panic selling, as investors fear the worst and liquidate their positions for cash. During a crisis, some financial gurus advocate sticking to your long-term strategy. Timing the market bottom may be tough, and even experts don’t always get it right, but there are a number of nice possibilities in equities that have taken a blow during the fall and may be strong long-term investments.

Final Thought

Investors cannot expect the stock market to continue to rise indefinitely. There will always be market corrections and crashes to bring the market back into line with economic circumstances. Investors should pay attention to market dips that occur in a single day and carefully examine assets to ensure that fundamentals have not altered in their portfolios.

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Adam is an internationally recognised author on financial matters, with over 669.2 million answer views on Quora.com, a widely sold book on Amazon, and a contributor on Forbes.