We’re pretty sure this would be one of the nightmares of most retail investors- You just invested a great sum, and the market plunges the next day. This will be the biggest trauma for the people as their hard-earned money will be gone. Of course, it will not happen in a single day.
“Stock Market Crash!”
Today, in our stock market institute blog, we will be discussing what to do, how not to panic, how to utilize these Stock Market Crashes to build more wealth, etc. in a stock market crash.
During a stock market crash, markets and index declines rapidly, with equity prices collapsing over the course of a few days. The fear in the investors reaches its peak which makes them liquidate both their losses and profitable positions. A stock market crash can be short-lived or even take years to recover to the previous levels. It leads to an extended recession and sometimes even an economic depression.
What does the Stock Market crash mean?
When the market, specifically it’s index declines (falls) more than 20% in a few days, this phenomenon can be termed a stock market crash. However, this decline can’t be associated with the exact fall of 20%, as it might be but somewhat near about it. Stock market crashes are uncommon, and rarest of investment opportunities. But its arrival results in huge widespread panic, losses, turning green, profiteering investment portfolios to blood red filled with losses. This is what a stock market crash means and impact in simpler words. This affects everyone, right from small retail investors to high professional institutional investors and many others.
Difference between a crash and correction:
There are no standard definitions for these terms, but the most widely accepted ones are as follows:
Correction: A drop of more than 10% and less than 20% is termed to be a correction. Correction tends to take place at a slower pace, taking time and making a drop less steep.
Crash: A decline of 20% or more in a few days is termed to be a crash. On the other hand, a crash is typically steeper since the drop happens at a faster pace.
Some of the biggest stock market crashes:
- The Dot-com bubble crash of 2000-2001, was triggered by the huge collapse of technology stocks. The reason being many companies raising millions of dollars just with a small internet adaption idea.
- The Great Recession Of 2008, which was triggered by the collapse of mortgage-backed securities in the housing sector, lead to a 54% decline in the Nifty Index just in a span of 3 months.
- The recent Covid crash of March 2020, which was witnessed by most people which was triggered by the lockdowns imposed because of the pandemic.
Now let’s understand the 5 major reasons behind the stock market crash:
Speculation is one the biggest reason behind overvalued stock prices. This further leads to asset bubbles, just like the dot-com bubble. In early 2000s, due to blind and massive investment in the dot-com businesses, tech stocks underwent a crisis in the late 1990s and early 2000s.
Similarly, the 2008 financial crisis was because of blind faith, negligence and huge speculation in real estate and housing. All of this was coined into the housing bubble. Once the bubble burst, large number of borrowers were unable to pay their loans. This led to many people losing their homes, jobs, savings, etc. and everything.
2- Political Instability
According to a study, the relationship between political unsuitability and stock prices is inverse. It means,
- The higher the political instability, the lower will be the stock prices.
- The lower the instability, the higher will be the scope for the bull markets.
Note: A highly stable government is one of the requirements that support a bull run in the stock markets.
3- Excessive Leverage:
Leverage, also known as borrowed money or purchasing power, can be a valuable instrument only if used wisely. When misused, it can eat up gained profits along with the invested capital. With falling prices, investors and businesses with high leverage and debt are obliged to sell, driving the prices even lower.
High-interest rates indicate high borrowing costs, locking the inflow of money into the markets. This lays down an adverse effect over several organs of the economy such as business investment, consumer spending, tax policies, etc. Whenever there is a negative impact on a country’s economy, stock markets get negatively impacted.
Sudden catastrophic events such as a supply shock, natural disasters, or pandemics like the recent Covid-19 outbreak in March 2020 resulted in bloodbath in markets.
Any of these reasons alone or combined with others might result in increased negativity in the stock market and thus can cause a crash.
Now here are the 4 ways to prepare for a stock market crash:
1- Diversify your portfolio
Diversifying your portfolio into several assets is the best measure to shield your investments from severe crash. These assets include investment into stocks, bonds, debt funds, real estate, cash deposits, derivatives, insurance, precious metals, etc. The allocation is purely based on risk tolerance and age to secure the investments.
2- Flying to the shore
When one anticipates or sees a crisis starting with signs of turbulence in the Indian stock markets, moving to debt instruments, cash or cash equivalents is the way adopted by the most investors. Moving out early in the crash and entering at start of recovery after a crash, rewards with humongous profits. It is better to be certain than to be early in the markets.
3- Give some portfolio space to guaranteed investments
It’s a bad idea to put all your savings in guaranteed investments that yield minimal returns. But it is wise to keep a small portion of your portfolio into assets that don’t fall with the markets. Examplesof such assets areBank CDs, Treasury securities, Fixed Deposits, Corporate Bonds, etc.
4- Clear Off Your Debts
If one has substantial outstanding debts, the best idea is to liquidate some of the holdings and paying off the debt when a bad weather seems to approach the markets. This smart step is exceptionally good if the interest rate on debts is too high. Debts like credit card balance, consumer loans, etc., have a higher interest rate.
This way, by the time bear market starts, loans are cleared, and one would have shielded themselves from the losses. One must also remember that one needs to reaccumulate and reinvest that money before one sense an optimistic environment. For more detailed information on ways to shield yourself from a stock market crash in India, check out this article: Link
Role of circuit breakers during a stock market crash:
During a crash, stock market safeguards curb heavy losses that occur due to panic trading.
Circuit breakers in Indian stock markets helped in halting the trading process during dramatic drops in the Indian Stock Market. These circuit-breakers are set at an index fall of more than 7%, 13%, or 20% at any time before 3.45 p.m. and halt the entire trading process for 15 minutes.
It is important to note that the natural cycle of all the stock markets including Indian Stock Markets involves rise and fall. Although crashes are scary and can cause inevitable crippling losses, but eventually, economies are bound to bounce back, making crashes as rare investment opportunities.
These stock market crashes, if used and invested wisely, are a strong cause for amplifying the investment portfolio. A good stock market institute in Delhi will help, motivate, and prepare you for the times of stock market crash.