Investing Assets & Markets Stocks What Is a Stock Market Crash? Its Causes and Effects, and How To Protect Yourself By Kimberly Amadeo Kimberly Amadeo Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact. learn about our editorial policies Updated on May 18, 2022 Reviewed by Thomas J. Brock Reviewed by Thomas J. Brock Thomas J. Brock is a CFA and CPA with more than 20 years of experience in various areas including investing, insurance portfolio management, finance and accounting, personal investment and financial planning advice, and development of educational materials about life insurance and annuities. learn about our financial review board Fact checked by Lars Peterson Fact checked by Lars Peterson Website Lars Peterson is a veteran personal finance writer and editor with broad experience covering personal finance, particularly credit cards, banking products, and mortgages. He has been writing and editing for more than 20 years and has a knack for digging deep into a subject so he can make it easier for others to understand. As an editor for The Balance, he has assigned, edited, and fact-checked hundreds of articles. learn about our editorial policies Share Tweet Pin Email In This Article View All In This Article What Causes Market Crashes? Effects of Market Crashes What Not To Do in a Crash Protect Yourself by Rebalancing Gold Can Be a Hedge Frequently Asked Questions (FAQs) Photo: The Balance / Theresa Chiechi 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 United States are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq. A crash is more sudden than a stock market correction, which occurs when the market falls 10% from its 52-week high over days, weeks, or even months. Each of the bull markets in the last 40 years has had a correction (and often several). It's a natural part of the market cycle that wise investors welcome. Such a pullback allows the market to consolidate before going toward higher highs. Key Takeaways 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 isn't a good idea to sell during a crash.Instead of panic-selling during a crash, you can prepare for one by rebalancing your portfolio with a diverse mix of stocks, bonds, and commodities like gold. Market Crash Causes To put it simply, frightened sellers cause market crashes. An unexpected economic event, catastrophe, or crisis triggers the panic. For example, the market crash of 2008 began on September 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. Investors panicked after Congress had failed to approve the bank-bailout bill. They were afraid that more financial institutions would go bankrupt the way Lehman Brothers had. Crashes generally occur at the end of an extended bull market. That's when irrational exuberance or greed has driven stock prices to unsustainable levels. At that point, the prices are above the real values of the companies as measured by earnings. A new technical development called "quantitative trading" has caused recent crashes. "Quant analysts" use mathematical algorithms in computer programs to trade stocks. Program trading has grown to the point where it has replaced individual investors, greed, and panic as causes of crashes. One example is the flash crash that occurred on May 6, 2010. The Dow plummeted almost 1,000 points in just a few minutes. Quantitative trading programs were shut down due to a technical malfunction. Effects of Market Crashes Crashes can lead to a bear market. That's when the market falls 10% beyond a correction for a total decline of 20% or more. A stock market crash can also cause a recession. Stocks are an important source of capital that corporations use to manage and grow their businesses. If stock prices fall dramatically, corporations have less ability to grow. Firms that don't produce will eventually lay off workers in order to stay solvent. As workers are laid off, they spend less. A drop in demand means less revenue, which means more layoffs. As the decline continues, the economy contracts, creating a recession. In the past, stock market crashes preceded the Great Depression, the 2001 recession, and the Great Recession of 2008. What Not To Do in a Crash During a crash, don't give in to the temptation to sell. It's like trying to catch a falling knife. A stock market crash will make the individual investor sell at rock-bottom prices. That's precisely the wrong thing to do. Why? The stock market usually makes up the losses in the months following the crash. When it turns up, sellers are afraid to buy again. As a result, they lock in their losses. If you sell during the crash, you will probably not buy in time to make up your losses. Your best bet is to sell before the crash. How can you tell when the market is about to crash? There's a feeling of "I've got to get in now, or I'll miss the profits," which leads to panicked buying. But most investors wind up buying right at the market peak. Emotions, not financials, drive them. Note What's the solution? Keep a diversified portfolio of stocks, bonds, and commodities. Protect Yourself by Rebalancing Rebalance your portfolio as market conditions change. If you've done that well, then perhaps you've sold off stocks after they've gained in value. If the economy does enter a recession, continued rebalancing means that you will buy stocks when the prices are down. When they go up again, as they have done historically, you will profit from the upswing in stock prices. Note Rebalancing a diversified portfolio is the best way to protect yourself from a crash. Even the most sophisticated investor finds it difficult to recognize a stock market crash until it is too late. Gold Can Be a Hedge Gold may be the best hedge against a potential stock market crash. A study done by researchers at Trinity College found that, for 15 days after a crash, gold prices increased dramatically. Frightened investors panicked, sold their stocks, and bought gold. After the initial 15 days, gold prices lost value against rebounding stock prices. Investors moved money back into stocks to take advantage of their lower prices. Those who held onto gold for past the 15 days began losing money. Most financial planners will tell you that the best hedge during turbulent times is not gold or any other single asset. Instead, you should have a diversified portfolio that meets your goals. Your asset allocation should support those goals. Frequently Asked Questions (FAQs) When will the housing market crash? While many analysts try to speculate, no one can say for sure when exactly the housing market (or any market) will crash. You can watch for warning signs in markets. For example, with the housing market, an analyst may want to track statistics, such as the mortgage default rate. Why did the cryptocurrency market crash? The cryptocurrency market crashes for the same reason as any other market. Crashes are the result of intense fear that causes sudden selloffs. Typically, there is an unexpected event that helps spark fear in markets. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Charles Schwab. "Market Correction: What Does It Mean?" S&P Dow Jones Indices. "Dow Jones Industrial Average," Download DJIA Daily Performance History. Tom C Lin. UCLA Law Review 678 (2013). "The New Investor." Abstract. Securities and Exchange Commission. "Testimony Concerning the Severe Market Disruption on May 6, 2010." Roger E.A. Farmer. Journal of Economic Dynamics and Control. "The Stock Market Crash of 2008 Caused the Great Recession: Theory and Evidence." Dirk G. Baur and Brian Lucey. Trinity College, Dublin. "Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold."