Stock market crashes may damage your portfolio short-term, but they create rare buying opportunities for prepared investors. This guide explains how to identify the best stocks to purchase during market downturns.
What is a Stock Market Crash?
A stock market crash happens when stock prices plummet by double-digit percentages across the entire market within just days.
Crashes represent one form of market correction — periods when stocks retreat 10-20% from recent peaks. However, “correction” suggests stocks will rebound after the decline. During a crash, markets might recover swiftly or enter an extended bear market phase.
Historical Market Crashes and Their Long-Term Impact
Major stock market crashes have struck approximately once per decade over the last four decades.
The Black Monday crash of 1987 witnessed the Dow Jones shed 23% of its value during a single trading session. While the market rebounded in subsequent days, it required two full years for the Dow Jones to completely recover its losses.
October 2008 brought another devastating crash as the Great Recession began. Congress’s rejection of a bank bailout plan triggered a 7% drop in the Dow Jones. Within a week, the index tumbled another 8%. This decline persisted until March 2009, with the Dow not recovering its pre-crash levels until 2011.
The COVID-19 pandemic sparked the most recent crash in February 2020. As the virus spread throughout the US and states implemented lockdowns, the Dow Jones plummeted 26% over four trading sessions. This crash featured a remarkably fast recovery — the index regained all losses by year’s end.
Preparing for a Stock Market Crash
Market crashes are inevitable components of investment cycles. Since they’ve occurred regularly throughout history and will likely continue, preparing yourself becomes essential.
Begin by developing a clear response strategy. Will you sell portfolio holdings or maintain positions expecting eventual recovery? If selling is part of your plan, identify specific stocks and predetermined price triggers.
Maintaining cash reserves proves invaluable during market crashes. This capital remains protected from crash impacts while providing funds to purchase discounted stocks without liquidating existing portfolio assets.
How to Choose Stocks During a Market Crash
Though crashes can devastate portfolios, they also present exceptional opportunities to buy stocks at substantial discounts. How should you determine which stocks deserve your investment? Consider these key factors.
Understand the Crash’s Character
Market crashes vary significantly in their nature. Some, like 2008’s decline, affect the entire market uniformly. Others disproportionately impact specific sectors. During the 2020 crash, “lockdown” stocks actually gained ground while broader markets collapsed. Future crashes might see tech stocks leading the downturn.
Understanding sector-specific responses to market movements guides investment decisions. The most severely impacted sectors may offer the deepest discounts relative to pre-crash valuations, though they typically require longer recovery periods.
Prioritize True Value
Focus on genuine value when evaluating crash-era stock prices — not merely percentage declines. Crashes sometimes occur when market bubbles burst, causing stocks to return to realistic valuations. A dramatically fallen stock might appear discounted while remaining overvalued based on fundamental analysis.
Carefully assess whether stocks represent true undervaluation following a crash before committing capital.
Identify “Future-proof” Companies
Market crashes provide opportunities to reassess which companies possess lasting power. Crashes often strain debt-heavy companies and those already losing ground to competitors. These vulnerable firms may struggle to survive downturns or recover afterward.
“Future-proof” stocks represent stable companies that will resume strong performance once crashes end. These stocks often become undervalued and overlooked during turbulent periods, yet deliver exceptional returns when conditions improve.
Evaluate Economic Conditions
While the broader US economy can trigger market crashes, it doesn’t always drive them. When economic deterioration causes crashes, consider future implications. Rising unemployment typically reduces luxury and travel spending while consumer staples and budget brands maintain stability.
Analyze the economic forces behind crashes and how shifting conditions will affect different companies.
Target Desirable Stocks at Discount Prices
Crashes create chances to invest in preferred companies at reduced prices. If you’ve wanted Apple shares but awaited a pullback, a crash might offer an attractive entry point.
Always reassess whether previously attractive stocks remain appealing amid crash conditions.
Strategic Tips for Crash-Era Stock Purchases
Beyond stock selection during crashes, several additional considerations matter when investing.
Assess the Crash’s Progress
Consider the market’s position within the crash cycle and potential future movements. If stocks have already fallen 10%, could they drop another 10%? Or has the market established a bottom with recovery signs emerging?
Generally, investing slightly late proves better than investing too early during crashes. Many investors suffer losses trying to catch falling knives. If you expect recovery, little harm comes from buying after rebounds begin.
Gradually Build Positions
Manage crash-era investment risk by building positions incrementally. Purchase stocks gradually rather than all at once, averaging your cost basis throughout the crash. For instance, instead of buying $5,000 of Apple stock immediately, invest $1,000 each time markets drop 5% or monthly over five months.
Match Your Risk Tolerance
Determine your acceptable downside risk level. Buying with hold-forever intentions exposes you to significant losses if markets continue declining. Conversely, using stop losses risks having positions sold just before recovery begins.
No single approach is universally correct. Your risk tolerance during crashes determines the best strategy.
Diversify or Choose Funds
While history shows overall market recovery after crashes, individual stocks don’t guarantee comebacks. Concentrating investments in few individual stocks during crashes increases risk.
Reduce this risk by spreading investments across multiple stocks from various sectors. Alternatively, consider funds providing exposure to major indices like the S&P 500.
Conclusion: Navigating Crash-Era Stock Investments
Market crashes present challenges but create exceptional opportunities for prepared investors. When investing during crashes, carefully evaluate affected stocks, underlying crash drivers, and which companies will emerge stronger.
Success requires understanding your risk tolerance and implementing strategies that minimize potential losses throughout the crash period.
