The Covid-19 pandemic caught everyone off-guard right from health authorities around the world to investors. Everyone across the globe had some common worries, including protecting their health and wealth. Apart from rising commodity prices and lower income due to multiple lockdowns, what worried people the most was loss of wealth due to sudden market crashes. However, this is not the first instance that markets have been turbulent to the extent of crashing.
If we look at the history of stock markets, we can observe that there have been multiple crashes over the last 2 decades. There is also a broader rhythm to these crashes, and closely studying the same can give us insight into the nuances.
There are many important learnings to be derived from stock market crashes. Here, we present top five lessons that investors can learn and be better prepared for a smoother investment journey.
Top 5 learnings from stock market crashes
Here are the top 5 learnings from historical stock market crashes:
1. Patience pays
During a market crash, it is normal for investors to become impatient and sell their holdings to either rebalance their portfolios or sell entirely. However, steady investors who have gained wealth in the long run tend to not only survive crashes but also end up gaining substantially during market highs. While there is no certainty about a market downturn and its timing, historical data suggests that the markets always recover regardless of how bad the crash would have been. Therefore, investors must continue to explore attractive investment opportunities and remain invested as per their plan.
2. Focus on individual portfolio
Certain common psychological behavior patterns are observed across various global market crashes. Some of these include herd mentality and overconfidence in decisions. These are best avoided and investors should instead focus on their portfolios while making decisions.
3. Avoid liquidating out of panic
Bear markets may last longer than one can imagine. In such scenarios, it is easy to be tempted to liquidate one’s portfolio. Very few investors sit tight with their investments and wait for the frenzy to be over. In such situations, investors should reassess their portfolio and try to rebalance the assets as per any alterations to the risk-reward profile.
4. Never speculate
Those who speculate in stock markets are often the ones who are hardest hit during market crashes. Speculation is best avoided by stock market investors who aim for wealth creation in the long run. While it can help in achieving short-term and one-off benefits, it can easily increase one’s overall portfolio risk.
5. Work with fundamentals
Investors should focus on investing in companies that have strong fundamentals. Companies that have the right risk-mitigating strategies in place tend to invariably come out of disruptive market events. Company fundamentals can win over other external factors in influencing the intrinsic value of the company’s stock in the long run. Focusing on this can lead to higher returns for investors, irrespective of market crashes.
History of Indian stock market crashes
- UPA election 2004 – In May 2004, the stock market fell 15.52% which is considered one of the largest crashes in the history of Indian markets.
- 2006 crash – In May 2006, the Sensex fell by 826 points to 11,391 as a result of the global market crash.
- Financial crisis of 2007–2008 – the Indian stock markets fell on multiple occasions in 2007 and 2008 due to the sub-prime crisis in the US.
- Crash of 2009 – In July 2009, the Sensex fell by 869 points to 14,043 as a result of the US housing market collapse.
- Crash of 2015 – In January 2015, the Sensex fell by 854 points to 26,987 as a result of worldwide sell-offs.
- Crash of 2016 – Resulting from NPAs of Indian banks combined with global weakness. A continued fall in 2016 resulted in an overall drop by 26% in eleven months.
- Crash of 2020 – Covid-19 – In early 2020, Indian stock markets fell by 13.15% as a result of the Covid-19 triggered lockdowns across the world. This was mainly due to increased fears of a recession.
Post a market crash, investors must first check their portfolios. It is important to determine which stocks have been most impacted. Rechecking the portfolio for high-risk stocks and including some safe options can help in minimizing overall impact. Market crashes can be used as an opportunity by investors to strategically reallocate their funds towards better-performing investments. In the end, it is crucial to remain patient since the stock markets tend to correct over time.
Stock market crashes result in an overall decline in the value of stocks before any improvement is seen. Due to a significant fall in stock prices, there is recession and insolvency, which further affects the growth of impacted companies. Investors can suffer substantial losses since market conditions do not improve quickly after a crash.
A stop-loss order helps in managing stock investments such that if the stock price falls below a certain level, the trade is settled automatically. This way, there will be some profit in the hands of the investor. This can be used to minimize the impact of a stock market crash.
Stock markets are often volatile. If these crash, they also tend to rise back. Therefore, an investor may not necessarily lose all the money unless he/she has not strategically designed the portfolio or tends to liquidate out of panic during a crash.
Multiple reasons may result in the stock markets to crash. Some of the common ones are economic changes, external economic situations, geopolitical issues, bear conditions, pandemics, etc.
Stock market investments carry a significant level of risk depending on the type of securities chosen for investment, timing of investment, volume, etc.