5 Things To Know About Stock Market Crashes and What They Mean | Exploring Markets

5 Things To Know About Stock Market Crashes and What They Mean

1. Stock market crashes can be entirely random. More importantly, they can be completely disconnected from the economy. In 1987, after the stock market suffered one of its worst drops ever, the White House issued the following statement. The economy was in perfect condition at the time:

"The President has watched today with concern the continued drop in the stock market. He directed members of his Administration to consult with the chairmen of the Federal Reserve, the Securities and Exchange Commission, the New York Stock Exchange, the Chicago commodities and future exchanges, and the leaders of the investment community. These consultations confirm our view that the underlying economy remains sound. We are in the longest peacetime expansion in history. Employment in at the highest level ever. Manufacturing output is up. The trade deficit, when adjusted for changes in currencies, is steadily improving. And, as the chairman of the Federal Reserve has recently stated, there is no evidence of a resurgence of inflation in the United States. The President is keeping close watch on the markets here and in other countries. We will continue to closely monitor these developments." - The White House, 1987

2. Stock market crashes should be a moment of opportunity. Not fear or panic. The prepared always prevail during stock market crashes. Always have cash on hand so you can participate when you want in times of massive selling. Warren Buffett says that perfectly here:

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett

3. Peter Lynch is a brilliant and famous long-term investor. He's said some remarkable things about preparing for crashes and corrections. His most notable point? They're almost impossible to predict. But they happen:

"If you’re in the market, you have to know there’s going to be declines. And they’re going to cap and every couple of years you’re going to get a 10 percent correction. That’s a euphemism for losing a lot of money rapidly. That’s what a “correction” is called. And a bear market is 20-25-30 percent decline.

They’re gonna happen. When they’re gonna start, no one knows. If you’re not ready for that, you shouldn’t be in the stock market. I mean the stomach is the key organ here. It’s not the brain. Do you have the stomach for these kinds of declines? And what’s your timing like? Is your horizon one year? Is your horizon ten years or 20 years?" - Peter Lynch

4. Always have some understanding of what a stock market crash is. There's no way to predict them. But there are ways to understand how they happen and accelerate. Below you will find a chilling account of the 1929 stock market crash. Focus on the tidbit about "margin accounts." Even today, this is true:

"Wave after wave of selling again moved down prices on the Stock Exchange today. Billions of dollars were clipped from values. Traders surged about brokerage offices watching their holdings wiped out. It was one of the worst breaks in history. For a time, in the morning, the market was showing signs of rallying power. Then new waves of selling out of poorly margined accounts started another reaction." - Minneapolis Star

5. The stock market is a vicious and ruthless entity. It has no emotions or feelings. With that simple thing being said, you should always have an exit plan and a strategy to avoid crashes when they start to happen. Set rules for yourself: I will always sell stocks at X price. Or I will always hedge my position by shorting stocks when they fall by 10% or more. This is essential:

"The most important rule of trading is to play good defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that so I can define my maximum possible drawdown." - Paul Tudor Jones