Strategies You Need To Navigate A Stock Market Crash
When stock markets fall sharply, the term "crash" dominates news headlines, social media, and investor discussions. A stock market crash refers to a sudden, steep drop in stock prices, often triggered by economic downturns, geopolitical events, or investor panic.
While there is no fixed percentage that defines a crash, its impact can be severe. Understanding the causes behind these crashes and adopting smart investment strategies can help minimise losses and improve long-term returns.
What Is A Market Crash?
A market crashes when there are more sellers than buyers for a stock causing prices to plummet due to excess supply. When many investors decide to sell at once, and there are not enough buyers to absorb the supply, stock prices decline sharply. These crashes can happen within hours or a single day. Once selling begins, fear spreads quickly, prompting more investors to offload their stocks, creating a snowball effect that accelerates the market downturn.
The 2020, Covid-19 pandemic led to a market correction of almost 30%1. It was the last stock market crash in India. At that time, uncertainty about the future led investors to sell off their stocks and cancel upcoming purchases, further driving the market downturn.
Reasons For Stock Market Crashes
A market crash can happen for several reasons. Let us take a look at some of these:
1. Economic Slowdown: When the economy slows down, company profits and sales decline as people have less money to spend, leading to poor sales. In response, businesses cut costs through layoffs or hiring freezes, further reducing consumer spending. Job losses result in lower disposable income, worsening the slowdown. Additionally, when profits decline, businesses often scale back their expansion plans, slowing the pace of any ongoing or planned growth initiatives.
A single bad economic news can make panic-ridden stockholders sell their shares, which in turn can increase market volatility. This pushes the stock market into a downward spiral.
2. Interest Rates: A country's central bank sets interest rates, impacting borrowing and spending. Higher rates make borrowing costly, slowing economic activity, while lower rates encourage spending. To control inflation, central banks raise rates, and when inflation is low, they cut them. If investors expect rate hikes due to rising inflation, they may sell stocks, anticipating slower economic growth.
3. Geopolitical Events: Geopolitical events like wars, trade wars, and terrorist attacks influence investor decisions. When a country faces these issues, its future becomes uncertain, and investors do not like uncertainty. As a result, investors prefer to stay on the sidelines and observe the market rather than remain invested. This leads them to sell their positions, fearing potential losses2.
For example, Russia is a major oil supplier to India. When the Russia-Ukraine conflict began in 2022, many investors sold stocks that led to Sensex and Nifty falling over 5%, because the future became uncertain.
Strategies For Surviving A Stock Market Crash
Investors need some methods for proper asset allocation and to survive a stock market crash. Some of them are listed below:
1. Understanding Economics
The reason for market crashes that we discussed earlier must be understood and closely monitored by each investor. Inflation data, RBI Governor speeches, and fiscal policy changes by the government must be carefully monitored by individual investors. These data points help investors assess broader market sentiment based on specific news.
Economic indicators like slowing GDP growth, rising unemployment, and weak corporate earnings signal an economic slowdown.
For example, if the RBI governor mentions that inflation is stubborn and might need some time to ease, it could indicate that a rate cut is unlikely soon. Anticipating this, investors might reduce their positions in advance.
2. Market Downturn Indicators
Investors should track key stock market indices like the Nifty 50 and Sensex, as signs of a downtrend can signal upcoming trouble for the financial market. Investors should also monitor price action and volume data of real estate, infrastructure, automobiles, and banking companies as these are some of the first sectors to witness selling.
During economic downturns, consumer spending on big-ticket items like homes, cars, and new technology declines, causing these sectors to suffer the most.
3. Risk Management
Investors can mitigate risks using financial instruments like futures and options to hedge their positions. Maintaining cash reserves provides a buffer against losses during downturns. Most importantly, adopting defensive strategies helps safeguard portfolios in uncertain market conditions.
Defensive strategies mean investing in low-risk assets and disposing of high-risk assets. Investors must also use strict stop losses in uncertain times to limit their losses.
4. Finding Opportunities In Market Crash
If investors anticipate a market downturn, they can explore alternative asset classes. For example, during stock market declines, investors often shift to gold, driving its price higher amid market crashes.
Investors also rush towards buying stocks in sectors like FMCG and pharmaceuticals because the products of these companies are always in demand whether there is a boom or a downturn. Hence, these sectors present a stock market crash opportunity.
Market crashes often introduce new investment opportunities as investment flows from growth stocks to defensive stocks. This can help investors find stocks at cheaper valuations.
5. Diversification
To protect against market downturns it is important to invest in a varied set of assets like bonds, real estate, and gold. This strategy is known as portfolio diversification and is significant for minimising risk. Diversification must also be made when investors are buying stocks. For example, investors must limit investment into a single industry or sector. They should also consider investing in companies across different geographical regions to mitigate geographical risk.
Diversification is crucial because underperforming assets can be balanced by well-performing ones, reducing overall risk. To diversify your portfolio into fixed-income securities like corporate bonds and securitised debt instruments, click the link below and explore rated, regulated and secured opportunities offering fixed returns of up to 14%. These links are non-market linked and hence support your portfolio during the market crash.
Conclusion
Stock market crashes often trigger panic among traders and long-term investors. It’s crucial to stay mindful and not be swayed by market noise. Effective risk management strategies should be applied consistently, not just during downturns. Remaining calm and patient is key to navigating financial crises successfully. Log in to Grip Invest if you want to diversify your portfolio beyond stocks and explore investment opportunities in assets like bonds for stable returns.
Frequently Asked Questions On Surviving Stock Market Crashes
1. How often does a stock market crash?
Stock markets do not crash according to a predefined timeline. Sometimes, markets do not crash for a few years, and sometimes, they enter a downturn that lasts for a few years. The most recent market crash was in 2020, before that in 2008, and so on. In between, there were many small downside moves ranging from 10-25%.
2. Where does the money go when the stock market crashes?
During a market crash, investors sell their holdings, and that money is either kept as cash in their bank accounts or that money is transferred to other assets such as bonds and gold. After selling the stocks in a certain sector, investors can also move their money to defensive sectors.
3. How does a stock market crash affect me?
The value of your stocks can fall below your buying price, and it can take some time to recover. In some cases, stocks can take a few years to recover after a crash. Stock market crashes take place in times of major economic issues. These issues can lead to job losses, business losses, and falling incomes.
4. Does real estate get affected when the stock market crashes?
Yes, when the stock market crashes, it lowers the disposable money with people. In such a case, people avoid investing in real estate. Those who hold real estate are sometimes forced to sell it to make up for losses in the stock markets during market crashes. Real estate prices can also fall during a market crash.
References
1. Science Direct, accessed from: https://www.sciencedirect.com/science/article/pii/S2214785320363756
2. Livemint, accessed from: https://www.livemint.com/market/live-blog/share-market-live-updates-sensex-nifty-bse-nse-stock-market-today-24-02-2022-russia-ukraine-tcs-adani-vedanta-vodafone-11645668766173.html
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