There are a few impactful events that cast a shadow of concern on the stock market. Topping the list is the stock market crash. In this blog, we will discuss various dynamics and facets of a stock market crash.
A stock market crash happens when the stock prices drop quickly and unexpectedly. There might be a variety of reasons that propelled this drastic and unforeseen drop in stock prices in the stock market. It encompasses economic instability, political factors, geopolitical tensions, speculation, inflation, etc. Ultimately, a stock market crash is the ripple effect of many factors that cause a downturn in stock prices.
Economic factors like recession and inflation lead to stock market crashes. Furthermore, factors like rising unemployment and economic uncertainties can contribute to the stock market crash. Let’s have a look at recession and inflation.
Recession: During the recession, people spend less and it leads to a decrease in corporate profits. It translates into a dip in share prices. As a result, people spend less. It creates a downward spiral. Furthermore, factors like rising unemployment and economic uncertainties can contribute to the stock market crash.
Inflation: As inflation creeps in, interest rates increase. Thus, borrowing cost increases leading to decreased purchasing activity. As a result, equities fall. Similarly, inflation induces fear and uncertainty in the market and makes investors worry about the future purchasing power of their interest. This is a concern, particularly in the case of fixed-income securities. Subsequently, the investor may start shifting the assets from stocks to other investment options. As a result, stock prices fall.
Speculation is one of the main reasons behind a stock market crash. It amplifies the volatility of the market. Thus it pushes the asset prices to unstable levels. This happens due to the unnecessary optimism leading to asset bubbles. When these bubbles burst, panic selling happens. It causes a sudden decline in the market. Further, speculators display a herd mentality and start buying assets expecting a quick gain. It can create a loop where prices increase due to demand, though there is no backing of the fundamentals.
A multitude of factors like geopolitical tensions, pandemics, natural disasters, global wars, and many more can make the market unstable. Fear and uncertainty impact the stock market and, it affects every move of the investor in the stock market.
Certain political factors hold the potential to send ripple effects in the stock market and cause stock market crashes. For example, significant changes in the policies of the government can be a reason for a share market crash. Similarly, elements like political instability or changes introduced in the tax laws can affect the investors. If they lose the faith, it can trigger market panic.
Stock market crashes impact investor behavior. Accordingly, when there is a sudden downturn in the market, it can lead to panic selling. Ultimately, it causes further decline and the situation gets worse. Further, a stock market crash influences risk tolerance and investment strategies.
During the pandemic, the market witnessed a loss of Rs.13.88 trillion. Following the nationwide lockdown, the Nifty and Sensex plummeted by 13%. The loss was visible in the large-cap stocks as well. They registered a decline of over 15%.
There was a severe stock market crash following the Indian government's demonetization decision and uncertainties of the US presidential election. As a result, the Sensex dropped by 1,688 points (6.12%)
When economic uncertainty prevails and investors rush for a quick exit from the market, it can turn into a stock market crash. The interaction of a bull market, bear market, and stock market bubble can amplify the crash in many ways.
It occurs when people are optimistic about the market. As a result, demand rises and exceeds supply. Subsequently, stock prices go up. It can last several years but a big event can diminish the confidence and rush people to sell the stocks.
You can expect a bear market scenario in the aftermath of a stock market crash. It is a scenario wherein investors fear losing their money and everybody starts selling stocks. As a result, the supply exceeds demand and prices drop.
The stock market bubble inflates and explodes as the investor follows the crowd and starts buying lots of stocks, which translates into higher stock prices.
It is prudent to diversify your investment options. Parking the money outside stocks will ensure a steady money flow even when the stock market crashes. Moreover, diversifying the portfolio will spread the risk across various assets and reduce the impact of any economic downturn.
When you invest in long-term stocks, you can minimize the short-term fluctuations in the economy. Moreover, long-term stocks that last ten to twenty years have the potential to give high profits.
Research plays a pivotal role in deciding the outcome of your investment. Hence, do not invest without enough research, particularly in case of a stock market crash. You should research and learn about various asset classes, the companies you choose to invest in, and the risks and returns involved.
It is like you are setting a threshold. If the value of your investment falls to that level or below, then it gets sold by default. Thus, it safeguards your asset from significant loss during a downturn.
Stock market crashes with its capacity to turn the tables play the most crucial role in a stock market. As a stock market trader, you need to navigate diligently with the help of research, guidance, and time-tested strategies.