Understanding stock market crashes: how to react

Stock markets are often said to climb a “wall of worry”. The higher they rise, the more investors start to fret about a possible crash. Can stock market crashes be predicted? What are the warning signs, and how should one react? Here are some answers.

While they often loom large in public consciousness, significant stock market crashes are relatively rare. Research from asset manager Schroders has found that declines of 20% or more – the accepted definition of a bear market – take place on average every four to six years. However, 10% drops – referred to as a ‘correction’ – are far more common, taking place in 30 of the past 52 years.

The biggest stock market crash in history took place between 1929 and 1932, helping to precipitate the Great Depression, when the US market lost more than 79% of its value. Over the past 50 years, the largest crash has been the bursting of the dot-com bubble in 2000, when the market lost 54% from peak to trough, and from which it did not recover its previous value until 2013.

Over-valuation and irrationality

There have been two other crashes in which declines exceeded 50%. One was between December 1972 and September 1974, when investors panicked about soaring inflation after the quadrupling of oil prices, complicated by the continuing Vietnam War and the undermining of the Richard Nixon’s administration in Washington by the Watergate case. The other took place in 1920, during the global influenza pandemic that followed World War 1. Smaller bear markets occurred at the onset of the Covid-19 pandemic in 2020, following Russia’s invasion of Ukraine in 2022, and the ‘Black Monday’ crash in August 1987.

The historical record suggests the causes of stock market crashes are often not predictable.

As the historical record suggests, the causes of stock market crashes are often not predictable. There might be, for example, extensive concern that markets in the US and elsewhere might be over-valued. Over-valuation was a contributing factor in market weakness when the dot-com bubble deflated and was followed a few years later by the global financial crisis, as well as in smaller, sector-specific market downturns, such as the commodity price slump in 2015 at the end of a so-called commodities supercycle. Crashes involve many investors selling assets quickly, which is more common when there has been a great deal of speculative buying, while over-valuation may deepen a crash.

However, it is seldom the only cause. As economist John Maynard Keynes famously said: “Markets can remain irrational longer than you can stay solvent.” Valuation anomalies can persist. There will usually be a separate trigger for a loss of confidence. Rising interest rates are often a catalyst. In 2022, for example, it was a sharp rise in inflation and the subsequent rise in interest rates after the onset of the Ukraine conflict that sent markets tumbling.

Ride a black swan

The anticipation of economic weakness is also a trigger for stock market weakness. Companies rely on countries’ overall economic strength to support growth in their profit, and when it looks as though the economy will turn sharply lower – as in 1929, the early 1970s or 2008 – it can prompt a stock market sell-off. However, it should be noted that markets tend to predict economic weakness more often than it actually happens in reality.

Markets tend to predict economic weakness more often than it actually happens in reality.

Geopolitical turbulence and war are also liable to spark stock market volatility. In particular, rising oil prices are a signal for investors’ concern about economic growth. In recent years, the diversification of energy markets has made economic growth less dependent on oil supplies, which may be why markets proved relatively resilient despite the surge in oil and price prices prompted by war in the Gulf in early 2026. However, significant oil price rises still have the potential to result in market turbulence.

Stock market crashes can also be caused by unexpected and unpredictable events – a notable example was the Covid-19 pandemic at the beginning of the 2020s. In the UK, the 1985 collapse of Barings Bank was precipitated by an earthquake in Kobe, Japan, which led to Asian markets tumbling and left rogue trader Nick Leeson holding highly leveraged loss-making investment positions that exceeded the bank’s financial resources.

Investors must think not only about the crash itself, but how long the market might take to recover.

How long does recovery take?

Investors must think not only about the crash itself, but how long the market might take to recover. Some crashes – Black Monday, for example, or the 2010 ‘flash crash’ caused by automated trading systems – are brief and markets swiftly recoup their losses. There are also cases in which in the wake of significant market sell-offs, investors realise that the impact will be relatively limited.

The longest periods before recovery have arisen where speculative valuations have combined with a prolonged period of economic weakness. Following the Great Depression, it took until November 1936 for the US stock market to return to its level in August 1929. What Morningstar calls the ‘Lost Decade’, encompassing the dot-com slump and the Global Financial Crisis, lasted in terms of the market from August 2000 until May 2013.

One should also remember that even within a bear market, certain sectors do well while others perform poorly. The period after the dot-com bubble burst in 2000 was a grim period for the US market as a whole, but certain sectors, such as tobacco and commodities, enjoyed significant price gains.

On the whole, stock markets tend to reward patience. Despite two calendar years of negative performance, the MSCI World Index delivered average annual growth of 13.65% over the 10 years to the end of May 2026. In the longer term, most crashes appear in retrospect as minor blips in markets’ long-term upwards trajectory. However, there are exceptions to this, notably in Japan, where after the bursting of a vast asset bubble in the late 1980s, the Nikkei 225 index took nearly 34 years to return to its previous peak of December 1989.

The perils of trying to time the market

Most investors recognise that short-term declines are the price of higher returns over the long term. However, most would prefer to avoid the volatility. The temptation is to try to get out of the market before it crashes and reinvest before it recovers. But this is extremely difficult, for a number of reasons. Markets are forward-looking and often have fallen before investors have the opportunity to cut their losses. The inevitable risk is that investors crystallise their losses when they sell up and struggle to find the right moment to reinvest.

Stock markets often start to recover long before there is any sign of improvement in the global economy, the resolution of a conflict, or a fall in interest rates.

Stock markets often start to recover long before there is any sign of improvement in the global economy, the resolution of a conflict, or a fall in interest rates. During the Covid-19 pandemic, markets started to recover months before a vaccine was in prospect. During the Global Financial Crisis, the market’s nadir was in March 1999, when economic and market shocks were continuing, corporate profits declining and unemployment rising.

According to JPMorgan, missing the 10 best days in the markets over the past 20 years would have reduced an investor’s average annual return from 11% to 6.6%. On an investment of $10,000, that means a return of just $35,866 rather than $80,619. Miss the top 40 days, and investors would be looking at a loss over 20 years. That explains why it pays to stay invested.

However, this is not to say that investors should not respond to changes in market conditions, such as trimming back exposure to sectors where valuations look too high and reinvesting in less popular areas of the market.

Diversification and regular saving always help to mitigate stock market volatility. But crashes are a feature of stock market investment, not a bug, and should not be feared by those with a sufficiently long time horizon.