Stock markets have three circles of hell in their inferno — a pullback, a correction, and a crash. Aside from the degree of pain they impose, these market downdrafts have different characteristics.
An efficiently functioning stock market is considered critical to economic development, as it gives companies the ability to quickly access capital from the public.
The concept behind how the stock market works is quite simple. The stock market lets buyers and sellers negotiate prices and make trades in a regulated and controlled environment. In the U.S., the main regulators include the Securities and Exchange Commission (SEC) and market participants under the purview of the Financial Industry Regulatory Authority (FINRA).
The nature of stocks, also known as equities, is that they suffer declines, although history shows they gain much more than they lose. However, when a market slide materializes, it triggers investor fear and panic.
Here is the difference between a stock market pullback, correction and crash.
A pullback, also known as retracement or consolidation, is a temporary drop in an asset’s long-term uptrend, with drops of about 5 percent to 10 percent. It is very short-term, lasting a month on average and taking another month to retrace the losses, according to Guggenheim Partners.
There have been more than 74 market pullbacks since the end of 1945, according to asset management and investment firm Guggenheim Investments.
Pullbacks occur when the market price of an asset briefly retreats. These temporary declines are anomalies caused by the basic law of supply and demand.
As a stock’s price increases, fewer buyers are willing to buy. Eventually as demand declines, prices start to fall to a point that attracts more buyers.
An example of a pullback is the Zoom Video Communication Inc’s (ZM) stock. The price generally increased throughout most of 2020 during the pandemic but was interrupted by smaller declines in price.
These dips could be considered pullbacks because the price trend quickly returned to its overall positive momentum.
Investors targeting a particular asset can find buying opportunities during pullbacks, although they would need to weigh other factors.
Pullbacks often result from news events that turn out to be of fleeting importance.
The market is said to be in a correction phase after a drop between 10-to-20 percent and can last a few months.
The average market correction lasts anywhere from two and four months and is frequently accompanied by adverse market conditions. However, corrections are often seen as ideal times to buy high-value stocks at discounted prices.
All 28 corrections over the past 50 years have been more than completely erased by a subsequent bull market rally.
The most important thing to know about a market correction is that you will not know it is a market correction until it is officially over.
“They’re never the same, for example, the stock market correction in February and March 2020 from Covid-19 lasted about three months. Meanwhile, the correction in September 2020 only lasted three weeks,” said Ed Canty, a financial planner with CFM Tax & Investment Advisors.
Because of their short-term duration, the year corrections take place very often is positive overall.
Since 1974, the S&P 500 has increased an average of around 8 percent one month after a market correction bottom and more than 24 percent one year later, according to Schwab Center for Financial Research.
Both the Nasdaq and the S&P 500 also experienced corrections in late October 2018.
Nearly every day there is an article warning of an imminent market crash. Even the best predictors are almost always wrong on the timing and listening to them is a recipe for lost profits.
Crashes are downturns of more than 20 percent. They are almost always the prelude to a recession, and they generally occur at the end of an extended bull market.
The market’s worst crash was in 1929, with the Dow plunging 70 percent until its July 1932 trough. The damage was bad enough that the Dow took 25 years — until 1954 — to return to its 1929 level.
A stock market crash occurs when a market index drops severely in a day, or a few days, of trading.
The main indexes in the U.S. are the Dow Jones Industrial Average, the S&O 500, and the Nasdaq.
Crashes typically occur when an unexpected negative event hits an overextended bull market and sparks a sudden, extreme bout of selling. Markets usually recover in the following months, so it is not a good idea to sell during a crash.
An unexpected economic event, catastrophe, or crisis triggers panic. For example, the market crash of 2008 began on Sept. 29, 2008, when the Dow fell 777.68 points.
It was the largest point drop in the history of the New York Stock Exchange at that time.
In March 2020, stock markets around the world declined into bear market territory because of the emergence of the covid-19 pandemic.
Photo: Trader Thomas Lee works on the floor of the New York Stock Exchange, Dec. 9, 2021. (AP Photo/Richard Drew)
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