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Hey everyone! With the stock markets bleeding red in the past few months, I thought it relevant if we talk about market downturns. Well, what are they? In short, Market Downturns refers to a period of time which the stock market continues to decline. A market downturn’s severity can be classified by market dips, market corrections and bear markets.
A market downturn can be a result of a multitude of factors such as high inflation, high unemployment, rising interest rates, political and economic unrest and more (most recently the Covid-19 pandemic). Simply put, it occurs when there is a sustained selling pressure that surpasses the buying pressure in the market. When markets continue to fall, fear in the market rises (there are various gauges for this, from VIX to the Fear and Greed Index) which can lead to more sell-offs.
Now that we know how market downturns occur, let us talk about the magnitude of market downturns!
Market Dip
The most ‘mild’ type of market downturn are market dips. They are typically temporary drop in the market/sector/particular stock. This would typically be due to various news events/anticipation of something that affects the security (example earnings release). That said, a dip can be just due to random market fluctuations and not due to any particular reason. Such dips can be relatively small movements (<10%) and typically quickly rebound back after.
Market Correction
Next, a market correction is when there is a 10 – 19.99% downward movement of a security from its recent high. An example of the market correction is the Down Jones Industrial Average, which is down 13.3% year-to-date.
Year-to-date: The first day of the calendar year (1 Jan) to the current date.
This is typically a sustained period of a downward trend, typically over a period of time. This could be due to a variety of factors, from overall macroeconomic climate to securities being overvalued and due for a pullback. Investors can use these market corrections to buy into their high conviction securities as part of their dollar-cost average strategy.
Bear Market
Finally we have come to a bear market. If the market continues falling and has fallen by 20% or more from its recent highs, it would then be considered in bear market territory. Most recently, we can see that from the Nasdaq Composite where it fell roughly 28% year to date! A bear market can also be identified when investors are becoming more risk -averse than risk-seeking.
A bear market can indicate long-term underlying factors that causes the securities/market to fall and the market will likely to continue its downward trend till such factors change. For a long-term investor, as it is difficult to time the bottom, it would be easier for one to DCA at regular market drops (eg every 5% drop).
Market Crash
Lastly, a stock market crash is not really considered a ‘market downturn’ but rather sudden drop in prices in a very short amount of time. This can be identified by large and sharp drops in the market that is much larger than the typical market fluctuations. Such market crashes are unexpected in nature and reasons only surface on hindsight. An example would be the market crash of 2007.
It is difficult for us as investor to predict a market crash and the only way to limit our downside would be through hedging or a diversified portfolio.
And there we have it! If you enjoyed this week’s phrase of the week, do drop me a follow as I do this every week! Would appreciate if you drop a clap if you have found this useful. Cheers!
-Rice
