Understanding an Unstable Stock Market

Big changes in the stock market often come with feelings of stress, uncertainty, and fear. Before getting caught up in online discourse or taking drastic action, it’s important to understand what’s actually happening and what it means for you.

To understand the state of the stock market, you’ll first need to understand the basics. As the name implies, the stock market is a marketplace for buying and selling stocks, which are portions of ownership within a company. Most often, people make money via the stock market by selling stocks for a higher price than they paid for them. Even if you haven’t purchased individual stocks on your own, money in many retirement funds (such as an IRA or 401(k)) is invested in the stock market.

One of the most common ways to measure the health of the stock market are indexes. An index is a collection of companies grouped together and tracked to make generalizations about the stock market as a whole. The most common indexes are the S&P 500, the Dow, and the NASDAQ. You can learn more about those here.

The stock market impacts and is a reflection of the state of the economy at large. When the stock market is doing well, that generally means people have more money to spare and feel confident spending it. When it isn’t doing well, that may not be the case.

One of the most common ways to measure the health of the stock market is in points. Points in the stock market are generally equivalent to value—if something has risen in points, it’s risen in value, and if it’s fallen in points, it’s fallen in value.

For an individual stock, one point often equals one dollar. That means that if a stock goes down in points, its value per share goes down an equivalent amount. So, if you owned stock worth $20 per share that lost 5 points, your stock would now be worth $15 per share.

Points in indexes work a little differently. They represent the value of the entire index, rather than any particular stock within it. If an index drops 10 points, that doesn’t mean every stock inside it dropped 10 points, nor does it mean only a single stock inside it dropped 10 points. Instead, it’s a way to show the overall value of the collection of stocks. Because of this weaker correlation, people will often refer to changes in an index or the market as a whole with points and the equivalent percentage change. This percentage gives you context, because it shows you how much the value has fallen or risen compared to recent highs. In general, the overall stock market usually only moves up or down around 1% each day, so anything higher than that indicates unusual changes.

A market correction is a term used to describe a drop in the stock market at large, but corrections can also happen to individual stocks, bonds, or indexes. While there’s no official definition, most people refer to a correction as a drop of 10-19%. The overall market is often considered to be in a correction if a large index (such as the S&P 500) is in a correction.

The name “correction” comes from the idea that, most often, markets will correct from this tumble. Few corrections actually end up resulting in a sustained drop in the market.

A bear market happens if a market doesn’t effectively correct or if there’s a more significant drop (at least 20%) in a short period of time. Bear markets are pretty infrequent, but will often last for a few months to a few years at a time. This is in contrast to a bull market, which is a period of time when stocks are growing in value. Bull markets are more frequent than bear markets.

As with a correction, there isn’t a specific definition for a stock market crash. Most often, the market is considered to have “crashed” if it has a sudden, severe drop. This drop is often over 20% and takes place over 1-2 days. Some people use the terms crash and bear market interchangeably, while others would consider a bear market less immediate and extreme than a crash. Many things can bring on a crash, including large financial or economic changes, general unrest and uncertainty in the market, or impactful world or national events.

Safeguards can help prevent or mitigate the damage from large changes in the stock market. For example, circuit breakers are a regulatory mechanism that temporarily halt trades after a large decline. This can help cut down on panic-selling, where lots of people attempt to sell stock after a drop in value hoping to mitigate their losses. Panic-selling can cause a struggling stock market to plummet farther, as the market will suddenly be flooded with supply and have little to no demand.

Experiencing extreme changes in the market can be stressful and overwhelming. The most important thing to remember is to avoid making drastic changes. It may be tempting to try to sell everything off before things get worse, but that will rarely give you a positive result. Most often, the best thing to do is to look to the future and wait out the uncertainty of the market. While it may take a few months or even a few years, the stock market has always returned to normal after a crash. Of course, it’s often easier said than done to wait out uncertain economic times. If you’re approaching retirement in a difficult market, this can help you learn more about specific steps you can take. You can also use the Weathering an Economic Storm Coach to learn more about specific steps you can take in times of economic and financial uncertainty.

Drops in the stock market are regular, expected occurrences. Understanding what’s happening and what it means is key to protecting yourself and your finances when these changes occur.