The stock market is a term referring to the buying and selling of stocks, equities and other financial securities. If you’re even the least bit interested in the stock market or have been a regular investor, you’ve heard the phrase “The share market is down today”.
What does this mean? Is it good? Bad? The answer depends on how you perceive it. In this article, we’ll explain what a stock market crash is, its causes, effects, and how you, as an investor, can deal with it without affecting your portfolio.
But first, let’s understand how the stock market works.
Stock markets are a secure and regulated environment where interested participants can transact in shares and other financial instruments. Companies who want to raise additional capital can list their company shares for sale on the stock market without losing control of their business. Investors can buy and sell a diverse variety of shares and corporate bonds, not just diversifying their financial portfolio but also adding to their wealth.
But investing in the Share market comes with a certain degree of risks. Share markets are known to be volatile with investors making radical profits one day to suffering significant losses the other. The biggest concern every investor has is related to stock market crashes and how it will affect their investments.
But first, it’s essential to understand this,
What causes the stock prices to change?
Share market is a volatile environment where stock prices change every day. This happens due to factors like supply and demand. If the number of people who want to buy a stock is more, it means that the need for that stock goes up. Simultaneously the price for that stock goes up too. Conversely, if there are more people who to sell a stock than the number of people who want to buy it, there is a greater supply of the stock than the demand for it in the market. This causes the stock’s price to fall.
As an investor or trader, understanding supply and demand is easy. However, what is more challenging to comprehend or understand are reasons to buy a particular stock or disliking another enough to want to sell it. Primarily, this also comes down to figuring out what news stories are positive for a company and what news stories are negative. This is a complex problem with every investor having their ideas and strategies to deal with it.
The principal theory in play is that the up and down price movement of a stock indicates what investors feel about a company and its worth. One of the critical factors that affect a company’s value is its earnings. In simple terms, earnings are the profit a company makes over and above the initial capital that was invested in the company. In the long run, every company must make profits to be able to survive in a competitive environment.
Several other factors influence the price of stocks and which way the market is heading. Apart from the factors relating to the business itself, the prices of shares are also affected by changing economies, inflation, interest rates, foreign markets, global finances and more. Investors must watch out for the changing developments to be able to stay on top of the market trends. This information prompts them to make decisions that will help avoid losses. When lots of stocks are affected to such an extent that it can cause a ripple in the market, it could very well lead to a stock market crash.
So, what is a stock market crash?
A stock market crash is when the prices of stocks drop severely in a day or two of trading. When a country’s economy is doing well, showing promising growth, stock markets tend to boom. However, a stock market crash is connected to declining global economies and poor performance of financial markets. There can also be other socio-economic factors which are out of anybody’s control. When we talk about share markets in India being down, it mainly refers to – National Stock Exchange (NSE) & Bombay Stock Exchange (BSE).
Several underlying factors cause the Stock Market to go down. Listed below are some of them to help you understand the signs of downward markets.
- Economic factors– Varying interest rates, declining economy, inflation, deflation, tax increases, financial and political shocks, changes in the economic policy, changing value of the Indian Rupee, are some of the many factors that can cause a decline in the share market. These situations are always a possibility and are beyond the control of investors. For a share market to crash, these factors must have to be so significant that they cause a change in the demand and supply of goods and services.
- Supply and Demand– This is another major factor that plays a role in the share market being down. The price of a share changes because there’s a change in the supply and demand equilibrium. When the demand for a stock is high but supply low, it causes the price of those shares to rise. Similarly, if the supply is high, but the demand is low, the share price decreases. This scenario becomes a hundred times bigger when there’s a disconnect between the demand and supply on a large scale, between various companies, which can, in the end, affect the entire share market. After all, the share market itself is a collection of many individual companies.
- Global Markets– One of the biggest reasons for share markets to go down is global economic trends. Indian economy is exposed to global markets with many foreign investors investing huge capital into Indian businesses. These big players and their more significant investments cause sudden activity in the share market resulting in extreme volatility in stocks. Indian companies also raise funds by listing their shares on foreign stock exchanges. When the world economy grows or declines, it has a significant impact on the shares of that company, which in result causes an effect on the domestic stock market. If global foreign exchanges drop, investors start anticipating its ripples to create a movement in share markets everywhere, especially India. If the worldwide decline is enormous, it can result in a decline in Indian share market too.
- International Events– Factors that affect stock prices often go beyond the economic conditions of foreign countries. These factors could include a radical change in the government of a stable country, war, internal conflicts, unforeseen natural disasters and more. There’s no predicting these events and what kind of impact they will have on our economy and subsequently on our share markets.
Share market crashes are temporary and don’t last for too long. That’s why it’s important that you don’t panic and make decisions in the heat of the moment. To help you know exactly what not to do during a share market crash, here are some tips and tricks.
What to do when the share market is down?
- Stay Calm: Yes, the share market going down can cause immense panic and cause you to think about selling your shares before you face massive losses. But, the best thing to do during a share market crash is to stay calm and not sell your shares. Don’t give in to temptation. Usually, you can make up for any losses incurred in the stock market within three months or so. The crash itself usually doesn’t last for more than two days.
- Stay Invested: History of financial markets, not just in India but also globally, is full of share market crashes. After every crash, the market is revived, and profits are yours again. The key is to stay invested through the low phase and wait for the markets to pick up again
- Consider buying more shares: During a share market crash, the prices of stocks fall drastically. Even companies that sell their shares for a high amount see a significant drop during crashes. You can profit from the market crash by buying more shares. Buy in regular intervals instead of all in one go as you can never tell when the crash will end, and the market will bounce back. Select companies that have performed well in the past have recorded high profits and have proper management with a decent franchise value. The chances of these companies recovering from the crash faster, are much higher. If you look at the brighter side, share market crashes allow you to buy shares of good companies and reasonable prices.
Most significant Stock Market Crashes in India
The Indian Stock market has witnessed its fair share of falls in the last few decades. Today, we’re growing rapidly, but this revival has happened after several downs that the economy had to face. Highlighted below are some of the most significant ones every investor must know about
- 1992: In the year 1992, the Indian stock market witnessed the most massive fall in its history, and this was primarily due to the Harshad Mehta scam that involved the manipulation of the stock market and securities.
- 2004: This was another of India’s biggest stock market crashes. After analysis, experts concluded that the crash was caused mainly due to a foreign firm selling large numbers of shares on behalf of unidentified clients.
- 2007: This was one of the worst years for the Indian equity market. The initial slump that started in 2007 continued till 2009, causing several significant dips, in succession, that affected the Indian share market.
- 2008: This is known as the year of the great recession globally. While India was not affected by the extreme, the global downfall was enough to pull down the upward swing of India’s stock market.
- 2015-2016: In 2015, the Indian economy was hit by a considerable bolt that caused the stock markets to crash. At the time when economy was steadily growing, the reason for the crash was concluded to be the slowdown in Chinese markets. Stocks began to sell rapidly in both China and India. Simultaneously, demonetisation was bought into play in India, and that added to the disruption caused to the economy. With so many hits, the stock markets witnessed such significant dips that it resulted in a market crash.
Market crashes are not permanent. Markets that are up must go down. And like we’ve seen from the previous market falls; the economy always revives itself. The crash is forgotten, and the share market is booming once again. So, that is reason enough that you shouldn’t worry too much about the ups and downs in the share market. Yes, they are a cause of worry, even to the most experienced investors. But remember that it’s best not to panic. Instead, stay invested and wait for the storm to pass. Also, the important thing for you to do as an investor is to educate yourself as much as possible. Read about the market trends, watch news about the global markets, and always keep an eye out for changing dynamics of the share market world.