What causes share prices to crash?
Stock markets have gone through times when share prices fall rapidly throughout history. There was the infamous Great Crash of 1929 – the worst market decline in US history where the Dow Jones lost 25%.
Then there was Black Monday in 1987, which started in Hong Kong and spread worldwide, where the UK’s FTSE100 share index fell by 22%. That was miserable.
Then there was the dot com bubble on 11 March 2000, which took 2 years to recover from.
More recently, we’ve had the financial crisis of 2008, which started with Lehmans Brothers going bust and contagion thereafter and of course the latest crash at the beginning of 2020 when the Coronavirus pandemic lockdown was announced.
In between all of these, we have surges in stock prices, known as bull markets and market corrections where prices fall, known as bear markets.
After a bull market, investors, stockbrokers and fund managers sometimes sell to realise their gains. When a lot of people do this at the same time, it can cause a market sell-off, which can in turn cause a downwards market correction. When everyone is selling, prices go down as states the law of supply and demand.
Here are 6 things to be aware of:-
Stock market corrections happen often
The first thing you should know is that stock market corrections happen — and fairly often. As worldwide economies peak and trough over time, the stock market will also have its peaks and troughs. According to research conducted by Deutsche Bank, the stock market, on average, has a correction once a year. While many investors, especially those new to stock investing simply aren’t used to experiencing swings like these, corrections are an inevitable part of stock ownership, and there’s nothing you can do as an individual investor to stop a correction from occurring.
Periods of tumbling share prices don’t last
In a broader context, while a stock market correction is an inevitable part of stock ownership, corrections last for a shorter period of time than bull markets. Based on research conducted on the Dow between 1945 and 2013, the average correction (which worked out to 13.3%) lasted a mere 71.6 trading days.
Times of falls in share prices are almost always unpredictable
Stock market corrections may be inevitable, but one thing they aren’t is predictable. Stock market corrections could come about within any time frame (every few months or after multiple years), and they can be caused by a variety of issues. For instance, we now know the impetus for the Great Recession was the bursting of the housing bubble caused by an implosion of subprime mortgages. But, how many people were echoing that subprime was a problem in 2006 or 2007? The answer is very few people were.
They only matter if you’re a short-term investor
Another important point you should realise is that stock market corrections really aren’t an issue if you remain focused on the long term. Corrections are more uncomfortable for shorter-term investors, who may have to switch their strategy to long term to make up for their losses.
They present an opportunity
For the long-term investor or a fund manager, a stock market correction is often a great time to pick up high-quality companies at attractive valuations. While trying to time a market bottom is generally a bad idea, a market correction can be a great time to add stocks to your portfolio that could make excellent long-term investments but that previously seemed a bit too expensive.
They are a good reminder to reassess things
As noted above, a dip in stocks isn’t necessarily a bad thing as it could give you or your fund manager the opportunity to buy quality stocks at bargain prices. It is also a good time to reassess your risk profile, your long-term goals, and financial objectives.
Generally, the best thing to do after a stock market correction is …nothing.
Accountancy Advice with THP
About Jon Gandell
Jon is an Independent Financial Consultant at Sterling & Law. He has 30 years’ experience, helping clients achieve their financial goals in a reliable, professional way. He specialises in pensions, investments and protection.
Jon is a family man, married with grown up twins, and a keen sportsman, regrettably an observer as much as a participator these days!