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The Difference Between a Stock Market Correction and a Crash

Thursday, March 12, 2020 | Sean Sechler
The Difference Between a Stock Market Correction and a Crash

Learning that the stock market is going down is never easy news for long-term investors to process. However, there’s a substantial difference between seeing the market go down for a small dip and seeing it experience a historically massive drop like on Monday. Investors just experienced one of the worst days in market history, so it’s natural to ponder whether the worst is over or whether it is yet to come. Volatility is at its highest levels in years and the market seems to be in a truly distressed state. This has led some to declare that the stock market is “crashing” while others are quick to dispute them and declare what we are currently experiencing is a correction.

It’s very important for investors and traders to understand the difference between a stock market correction and a stock market crash. A crash is something to be more concerned about as an investor while a correction is a natural part of the market’s cycles, which is why knowing the difference between the two can really serve you well during periods of increased volatility. Let’s take a look at the difference between a stock market correction and a crash below.

What is a Stock Market Correction?

First, let’s take a look at what a stock market correction entails. A correction is normally considered to be a 10% drop in the overall market from the latest highs. Most investors are referring to the overall market when they mention corrections, but you can look at the percentage drops in major indices like the S&P 500 and the Dow Jones Industrial Average to confirm that a correction has occurred.

Corrections are a normal part of the stock market and are a fairly common occurrence, but it always feels stressful to endure one as a long term investor. Stock market corrections can occur for a variety of different reasons, including fundamental issues related to the economy or uncertainty in the world. They normally don’t last too long, which is good news if you believe what is happening in the market right now is a correction. A correction can be a good thing for the market, as it can provide time for consolidation before the market begins moving to new highs. The bottom line is that you should expect corrections as an investor and understand that they usually only last for a few weeks or months.

What is a Stock Market Crash?

If a stock market correction is something that investors anticipate from time to time, a stock market crash is different in that it catches everyone off guard. A crash is a surprising and concerning event that can be truly devastating for the economy and the stock market as a whole. These happen when the market experiences an extremely sudden and sharp drop in prices. A crash is extremely rare and happens very quickly, often in the span of a single day or week.  Look no further than the 1929 crash which ultimately led to the Great Depression to understand just how big of an impact a stock market crash can occur.

One of the main reasons for a stock market crash has to do with market psychology. These events are largely driven by emotions such as panic and fear. The market tends to despise uncertainty, which is why we have seen such sharp declines related to the Coronavirus news in recent weeks. A stock market crash is usually followed by a bear market, which is when the market falls for a total decline of 20% or more from recent highs.

Did We Just Experience a Crash?

Many investors and financial experts are trying to determine whether or not we just experienced a stock market crash over the past few weeks. Although the sharp drop in the market meets a lot of the same characteristics that we mentioned above, we still haven’t reached a bear market yet. Only time will tell if the recent sharp downturns in the market were simply a harsh correction or a sign of a bear market to come.

It’s always tempting to consider selling during times of increased volatility, but doing so can lead you to miss out on a potentially epic rally off of the bottom. History shows that staying patient can pay off big in the long term, but everyone’s personal risk tolerance levels are different. Whatever happens with the market going forward, just make sure to keep your emotions in check and understand that there are ways to protect your downside other than selling your entire portfolio.

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