Stock market crashes can come as a bit of a shock and may be a result of a recession or a sign that one is looming. If you’ve got some money invested in the stock market, crashes can be pretty daunting, particularly the first time you experience one. Try not to panic when you see your stock portfolio decline in value – rushing to sell out may end up making things worse in the long run.
Here’s more information on stock market crashes, how they occur and what you should do as an investor.
What is a stock market crash?
Share prices can rise and fall on a daily basis, but when values drop drastically or unexpectedly, that can be a sign of a stock market crash.
In films, this is usually illustrated as panicked bankers running around trading floors and shouting down phones – nowadays, you are more likely to spot a crash on a share-price graph or by logging into your portfolio on an investment platform.
When do stock market crashes happen?
There are plenty of factors that influence share prices such as a company’s financial reports, economic data or the political, social and economic environment. One of the key influences on a share price is sentiment and the market mood. Investors can be pretty sensitive, so bad news can regularly cause a stock to drop in value.
In normal times, an investor would check a company’s fundamentals to assess if a drop in value is temporary. Panic can set in if company data or a political or economic announcement leads investors to believe a share price is overvalued or is heading for a fall. Demand for shares may drop or investors could start selling out. This may cause others to panic and do the same, causing a domino effect. Imagine someone shouting fire in a building, as word spreads, people that never even saw the fire would react, which can create mass panic, with everyone rushing to the doors. The same tends to happen when a share price collapses.
What does a stock market crash look like?
A stock market crash is a large fall in share prices. There is no official definition of a stock market crash but essentially you may see the value of your whole portfolio or certain shares decline. The impact isn’t just in monetary terms – the companies you are investing in may be in trouble and have to make changes such as laying off staff or even closing.
This can affect a whole market or particular sectors such as technology or banking stocks but if the companies are large enough, such as in the 2008 financial crisis, it can impact the wider economy.
Some experts say a crash is defined as a fall of more than 10% over a few days or weeks. It can also be defined as when stocks enter a bear market, which is when valuations fall by at least 20% from their peak.
Depending on how big a crash is and how companies, politicians and policymakers react, a stock market crash can also cause a recession as poor business performance can create corporate failures, unemployment and increased debt defaults.
Can stock market crashes be prevented?
Some indices have put procedures in place since Black Monday in 1987 to calm markets when there are fears of a crash, known as circuit breakers. These temporarily halt trading during a severe market decline to limit panic selling.
Circuit breakers are different depending on the stock market. For example, the New York Stock Exchange has a 3-tiered circuit breaker. It will pause trading activity for 15 minutes if markets decline by 7% or 13%. Markets could be closed for the rest of the day if valuations fall by 20%.
In contrast, the London Stock Exchange monitors individual stocks, and if it spots high levels of volatility, it will put the company’s shares into auction to determine a fair price and hopefully calm the market.
When was the most recent crash?
The most recent stock market crash was in 2020 as the coronavirus pandemic spread across the world. Most people will remember the start of the pandemic as a time of uncertainty as they had to become familiar with social distancing rules, lockdowns and homeschooling.
The coronavirus pandemic had a huge impact on stock markets. The prospect of business shutdowns, border closures and lockdown restrictions to avoid infections created panic among investors who were unsure how whole sectors such as travel, hospitality and leisure would survive.
On 12 March 2022, travel bans and lockdown restrictions began to be introduced. As a result, stock markets including the S&P 500, the NASDAQ, the FTSE 100, the DAX and CAC 40 in France fell by around 20% each, with the day later called “Black Thursday”.
Trading was suspended at several points by the New York Stock Exchange in March and the Dow Jones fell by 12.9% on 16 March and by 23 March had lost 37% of its value since 12 February.
What do I do if the stock market crashes?
Despite seeming like catastrophic events, stock market crashes are actually a regular feature of an economy. Markets can become too overheated as investors get overconfident, leading to drops in prices and sometimes a crash.
It is easy (and often tempting) to panic at the prospect of losing money, but long-term investors shouldn’t really worry about short-term crashes as losses should be smoothed out over a few years or decades. Many stock markets have already recovered or returned close to their pre-pandemic levels. If you had sold out when the markets crashed, you would then have missed out on the recovery and rally.
Crashes are more of a concern to day traders who are trying to make a quick profit on a daily basis. If you have a long-term investment strategy and are keeping an eye on a company’s fundamentals such as its financial health as well as any analyst reports and outlooks, then a stock market crash should only be a short-term concern that you can hopefully afford to ignore.
How to tell if the market is about to crash?
It can be hard to spot that you are in a crash until it happens. But there are some signs to watch out for.
Company valuations are an important indicator of confidence.
When values get too high, investors may think there is a bubble and start questioning how sustainable a stock price is. If there is too much doubt, the bubble could burst as investors sell or stop buying a stock, causing a crash.
One way of assessing if a crash is coming is by looking at a company’s price-to-earnings ratio. This measures a company’s latest share price against its earnings per share figure. A high ratio may suggest a stock is performing well and is set for growth but it could also mean it is overvalued if it is way above its rivals. Similarly, a company may appear undervalued if the ratio is below others in its sector.
Big political, social or economic events can also have an impact on the stock markets.
These are known as “black swans” as they are rare and unexpected and can knock the markets by questioning conventional wisdom.
Major unforeseeable causes of stock market crashes include the coronavirus crash of 2020, the financial crisis of 2008 and also the 11 September 2001 terror attacks. There was no way that the markets could predict these, so it is hard to price them in or prepare for them with an investment strategy.
The coronavirus crisis tested preparations for an unknown health pandemic, the financial crash of 2008 questioned the idea of banks being too big to fail and the 11 September terror attacks hit the operations of major banking and investment firms based in and around the Twin Towers while also hitting airline and insurance stocks with fears of how they would cope with claims.
Central bank actions
Central banks such as the US Federal Reserve or the Bank of England have tools to help manage the economy and try to keep inflation under control.
This includes setting interest rates and purchasing government bonds to inject money into the economy, known as quantitative easing.
These measures can help reassure investors as it shows action is being taken to help the economy. But changes that are unexpected or go further than anticipated such as a larger than predicted rate rise can also cause panic and harm confidence. Investors may start selling holdings in stocks that are seen as too risky or unsuited to the changing economic environment. Once that starts happening and everyone follows, stocks can then crash.
Can I sell my stocks during a stock market crash?
It is usually possible to sell stocks during a stock market crash as long as markets are open. The trouble is you don’t always know you are in a crash until after the event.
There may be occasions where trading is halted in extreme cases of volatility. This may affect a whole exchange, sector or just one stock. In this case, you would have to wait for the market to reopen so you can sell, but by that time the price could be different. Selling may not be the best strategy, as you could get a lower price than what you purchased a stock for, plus you could miss out on any future profits from a recovery.
You shouldn’t sell a stock just because the market is crashing. Short-term falls shouldn’t matter if you have a long-term investment strategy and a diversified portfolio should offset any losses. This doesn’t mean you should ignore a crash, but it could be a good time to check your portfolio, understand where your money is invested and assess if the issues are short- or long-term for your stocks.
What if the crash occurs outside of trading hours?
Stock prices can move once trading ends. This is known as after-hours trading.
It is usually used by traders who want to respond to events that have come out since the market closed such as earnings reports. You could still buy or sell stocks if they crash after hours but it will depend if your broker or investment platform offers an electronic communication network to do this through. The market can also be more volatile as there is less demand and supply, meaning prices can be more unpredictable.
Should I buy stocks in a crash?
Some investors see a stock market crash as an opportunity to buy stocks at a low price, known as “buying the dip”. The idea is to buy a stock that has recently fallen while expecting it to eventually rise again.
This is a lot like shopping during the Christmas sales — stocks may seem unloved and neglected, but that doesn’t mean they aren’t worth buying and you could pick up a bargain.
That doesn’t mean all stocks will be a bargain, as there may be other reasons why some have declined and may not recover. For example, shares of former retail giant Debenhams were at under 2p in 2019 but this was when the brand was going bust and subsequently delisted from the London Stock Exchange so would not have been worth buying.
It is important to do your research and check a company’s business plan, finances and outlook to understand its growth prospects. There may be some sectors that do better after a stock market crash.
Many investors flocked to “stay-at-home” stocks as the pandemic began to gain exposure to companies likely to benefit from lockdowns and the shift to home working such as Zoom, Netflix and Peloton. Zoom’s share price started 2020 at $67 (around £56) and ended the year at $345 (about £290), a 414% increase. Investors flocked to the stock to take advantage of the way the video-conferencing tool was helping with the shift towards remote working. Since workers started a gradual return to the office, the price has since started to drop, underlining the importance of monitoring stocks and knowing when to buy in if you think it will grow more, sell out if you think more drops could come or hold on if you think there is still value in the stock.
Should I sell my stocks if the stock market crashes?
Patience is a key virtue when investing in the stock market.
Selling up when the stock market crashes is risky as you could be left with a loss compared with what you invested. You may also miss out on a future rally as markets will eventually bounce back and recover after a stock market crash.
For example, the Dow Jones grew 57% in the 2 days after Black Monday in 1987 and was back to its pre-crash levels within 2 years. Investors will have missed out on this rally if they had sold out straight away.
This shows that it is important to check why stocks are crashing and understand the context. Assess your portfolio before rushing to sell to see if the issue is to do with the companies you are invested in or whether there are wider and temporary political, economic or social reasons for a share price crash that could be resolved in the long term.
Who benefits from a market crash?
A stock market crash can cause a recession as companies suffer from a lack of investment and consumer confidence is hit. It can have a real-life impact as businesses may see their profits suffer and could cut jobs or wages, plus they could also raise prices to make up for their losses.
But some sectors may also benefit when a stock market crashes.
Certain industries or assets such as gold, income stocks, healthcare, consumer staples and utilities tend to do well or are at least not as badly hit by a crash as they are seen as safe havens.
Investors may rush to these types of stocks as they are seen as essential in all economic environments so may be shielded from the worst of a downturn.
Can a robo-advisor help with a stock market crash?
Robo-advisors have become attractive ways for investors to access automated portfolios to gain exposure to the stock market. These providers build low-cost portfolios, usually consisting of exchange traded funds, that allocate investor money to particular assets depending on a user’s attitude to risk.
With a robo-advisor, you have very little choice about how your money is allocated. The “robo” aspect refers to how the portfolio is set up online, but there are humans behind the scenes still keeping an eye on your portfolio. You just have to rely on a robo-advisor’s human investment committee, which will regularly monitor a portfolio and rebalance it when they decide it is necessary.
This can be beneficial as it can stop you from making a rash decision and keep you invested for the long term, but you also have to trust that your robo-advisor will have set the portfolio up in the best way to navigate uncertain markets.
Many investors will have learned about the Wall Street crash of 1929 and may well have lived through an actual crash and seen how it can hit their stock portfolio during the 2008 financial crisis as well as the 2020 coronavirus crash.
Patient and prudent investors who didn’t act too hastily and stuck with their stocks will have seen their portfolio recover, while those who rushed to sell may only end up cementing a loss and missing out on a recovery, making the situation worse than necessary.
As long as your portfolio is well researched and monitored, and you remember why you are investing, stock market crashes should make interesting rather than worrying reading.