Historical stock market crashes and the ensuing bear markets have occurred often enough that investors can be confident in their ability to predict them. Stock market crashes are not isolated events, but rather recurring cycles that occur at fixed intervals as part of a larger economic cycle. Many people view the boom-and-bust cycles of the stock market as evidence that it’s inherently risky and not a suitable place for long-term investment. But savvy investors know that crashes present opportunities for value investors to buy stock at a discount. This article explains what causes crashes and bubbles, why they happen, and how you can stay safe during one.
What is a Stock Market Crash?
A crash is a sudden and severe drop in stock prices. Crashes are often related to financial crises, but they’re not triggered by inflation or rising interest rates. They can result from a large sell-off of stock, as people lose confidence in the market. The Dow Jones Industrial Average (DJIA) is a commonly quoted indicator of stock market performance. The DJIA goes back to 1896, but the S&P 500 (Standard & Poor’s 500) is a better measure of performance because the composition of the index has changed over time. Crashes are measured by the decrease in the S&P 500 from its previous high. The Great Depression saw the S&P 500 fall 83%, from a high in September 1929 to a low in July 1932.
Why Do Stock Markets Crash?
Stock markets experience periods of rising prices followed by periods of falling prices. The increase in prices is called a bull market and the decrease in prices is called a bear market. Stock market crashes happen when the market enters a bear phase. A bull market is characterized by a great deal of investor optimism, with people buying stocks at increasingly high prices. A bear market is characterized by a lack of investor optimism, with investors selling stocks at low prices. After the fall of the dotcom bubble, the bear market of 2001-2003 was followed by the housing bubble. This was followed in turn by the commodities bubble and then the emerging markets bubble. Each of these bubbles saw massive increases in prices followed by equally massive declines. Investors can avoid getting caught in a bubble by removing some of their money from stocks when prices are increasing.
History of Crashes and Bear Markets
Prior to the Great Depression and the New York Stock Exchange crash of 1929, there were four notable stock market crashes in U.S. history: – Great Depression: The Great Depression was the worst economic downturn in modern history. It began with the stock market crash of 1929, which sent Wall Street stocks plummeting. The economy continued to decline for almost a decade. – Panic of 1893: The Panic of 1893 was caused by the expansion of the money supply during the Sherman Silver Purchase Act of 1890. – Panic of 1907: The panic was caused by a drop in the stock of the United Copper Company which was followed shortly after by the New York Stock Exchange’s suspension of trading for 10 days. – Panic of 1901: The panic was caused by the repeal of the Sherman Silver Purchase Act, which had expanded the money supply by purchasing silver from domestic miners.
What Happens During a Stock Market Crash?
A stock market crash is a sudden and severe drop in stock prices. Crashes are often related to financial crises, but they’re not triggered by inflation, interest rates or other economic factors. They can result from a large sell-off of stock, as people lose confidence in the market. The Dow Jones Industrial Average (DJIA) is a commonly quoted indicator of stock market performance. The DJIA goes back to 1896, but the S&P 500 is a better measure of performance because the composition of the index has changed over time. Crashes are measured by the decrease in the S&P 500 from its previous high.
Strategies to Protect Yourself During a Crash
– Stay invested: The stock market goes through cycles, so you can’t avoid crashes and bubbles. But you can protect yourself from the worst effects of a crash by staying invested the majority of the time. – Diversify: Diversifying your investment portfolio will help you manage risk and protect yourself from a market crash. In addition to stocks, you can also consider investing in bonds, real estate, gold and other commodities. – Invest for the long term: Short-term trading is risky because you don’t know what the market will do tomorrow. Instead, focus on long-term investment — five years or longer. – Be flexible: Be ready to adjust your investment strategy if the market heads in an unexpected direction.
Final Words
As you can see, stock market crashes happen in predictable cycles. The best way to protect yourself is to stay invested and diversified over the long term. Be flexible and ready to adjust your strategy as the market shifts. And remember that crashes happen when investors are overconfident, so it’s important not to get too cocky. Stay informed and be ready to sell when prices are high and buy when they’re low.
