Crash or Correction?

The last few weeks have been a tumultuous time for share markets. We have seen large declines in share prices but how do you know if a share market is crashing or having a correction?

Definition of Crash and Correction

A stock market crash is a sudden drop in share prices caused by fear and panic. A crash occurs when the market falls more than 10% in one day. A market correction is normal for share markets and this occurs when there is a more gradual decline in prices. It occurs where there is a fall of more than 10% from the most recent peak before share prices start to recover again. Corrections can occur over days, weeks and months. It is healthy for a market to have corrections along the way. The stock market can have more than one correction in a year.

What is the difference?

The main difference between a correction and a crash is the size of the decline in the stock market. Crashes are more severe and can lead into a bear market. A bear market is defined as a 20% drop from its recent high.

Bear markets occur when investors lose confidence in the stock market and the underlying emotion is fear. These markets are also associated with a weak economy. Bear markets occur when the economy is in a recession or when unemployment is high.  A crash occurs during a global crisis or when the economy is fragile.

What causes a correction?

A stock market correction can happen after a period of rising share prices and investors believe the stock market is overheated.  A correction occurs when there is news relating to the broader economy which may panic some investors causing them to sell. As other investors see this panic they may also be motivated to sell as well causing the share price correction. A correction is only short term and after a few weeks or months, the share market will recover again.

Stocks most affected in a correction or crash

High growth stocks and stocks which have a higher beta than the market are usually the stocks which are hit the hardest when the market has a huge decline. Consumer staples and other smaller beta stocks are less likely to see the same share price decline.

Lauren Hua is a private client adviser at Fairmont Equities.

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