- Date : 24/04/2022
- Read: 4 mins
All Markets go through stages of a pullback, correction, and crash, which are inevitable; However, these troughs fade over time and the market achieves its peaks again.
The stock market is a holy grail many investors cannot help but plunge into. They all experience their share of agony, some are bruised, while some rise like Phoenix from the ashes. However, being in the quest for that pinnacle is every investor’s resilience to stay on course and keep riding the troughs and peaks as they come along.
The three dooms could be triggered by anything, but they all are distinguished by their plunging values while only the depth differs. A Pullback plunge is around 5%, a correction around 10%, and a crash is around 20% and more. It is the investor's job to understand the triggers for these value freefalls and take decisions of either pulling out or ignoring their impact. Each of these factors could initiate a decision to sell or to remain invested as their peaks could be higher than where they were prior to the fall.
Understanding Market Pullback
A pullback occurs primarily as a result of the news of impending chaos but somehow the fall doesn’t last beyond a month, and it takes another month to retrace the peaks. A government's financial decision, such as an increase in tax percentage on commodities, can trigger a pullback. The reason for a pullback in the market could also be an impending election with a new government expected with maybe a different fiscal policy. For all of these, the fall is around 5–10%, with a quick recovery. During this period, a panic sale could result in investors leaving the market up to a point in the free fall while other investors buy and cushion the trough, knowing that the rise is expected soon. Since World War II, the USA has experienced around 84 market pullbacks, averaging 1 every year and averaging a 7% loss.
Understanding Market Correction
Market corrections occur a lot frequently with the last one just hitting recently in January 2022. Many investors were triggered by Russia's plan to attack Ukraine, and panic selling ensued, leading in the S&P hitting a new low of 10%. This was the lowest trough since a 34% drop in the first quarter of 2020 owing to the beginning of COVID-19 in December 2019.
The reasons for a correction to occur are generally serious in nature. War or the beginning of the war has a tremendous impact on corrections. The impact of the US-China Trade deficit with the USA and the subsequent banning of Chinese-manufactured goods in 2018 made the Dow Jones nosedive 10%, while the S&P dove the same and the NSE dipped 8%. Delving into the reasons, there were quite unique findings. The stock market hit a low due to investor despair, even though unemployment was at an all-time low and GDP was robust. President Trump’s order against Chinese businesses sent alarm bells ringing. But within 3 days, the NSE jumped 1000 points. So it was a quick recovery despite the trough reaching correction levels. Corrections again drive the market back on course as market highs reach noteworthy peaks post-correction. On average markets tend to produce 10% growth after a correction takes place. The markets reach a new high as investors rally, throwing down the gauntlet to correction negativism and bolstered by financial and employment stability.
Understanding Market Crashes
Market crashes have the worst impact on stocks. Some are the harbingers of bad days ahead as the country’s business system collapses. The impact Lehman Brothers had on the financial markets worldwide in 2008, when the country went into recession, is a case in point. Some markets take more than 2 years to rebound from recession levels. The worst known crash was in 1929 when the Dow Jones plunged 29%. Crashes are known to have a global effect, with life in developing countries being affected the most. Chaos reigns in Sri Lanka at the moment, with violence breaking out in the streets due to prices of essentials skyrocketing. The government there has stepped in time to prevent the situation from spiraling out of control. It is apt to mention here that the crash of 2020 was cushioned by the high amount of government support for the financial sector to provide the necessary impetus for the economy to bounce back again. Otherwise, markets sometimes take more than 4 years to recover after a market crash, mainly due to recession setting in as a result.
In a nutshell, most markets provide an average 10% upper limit premium for their investors annually. It is better that new players understand this before investing. There would be some years when markets would pullback or reach a correction stage and might even crash, but eventually, they would rebound and stabilise and continue to provide the average of 10% returns.