Stock Market Crash Explained: Why It Happens and How to Invest

The stock market has been the heart of global finance for over a century, but sometimes it skips a beat. Examples of stock market crashes in India include the Harshad Mehta Scam of 1992, the demonetisation shock of 2016, and the COVID-19 crash of 2020. All these events show that markets that rise too high eventually fall.

A stock market crash is a part of the investing journey, and how you react makes all the difference. In this blog, we will explain what a stock market crash is, the reasons behind these crashes, their consequences, various investment strategies to manage them, and the role of central banks during stock market crashes.

Table of Contents

• What is Stock Market Crash?
• Causes of Stock Market Crashes
• Consequences of Stock Market Crashes
• Major Stock Market Crashes in India
• Different Investment Strategies for a Volatile Market
• The Market Crash Cycle: Bull to Bear Markets
• Key Factors to Consider Before Investing
• 2025 Stock Market Crash in India
• Role of Central Banks in Market Crashes

What is Stock Market Crash?

An unexpected or sudden drop in major stock market indices like the Nifty 50 or BSE Sensex is known as a stock market crash. It is generally caused by panic selling, economic downturn, or external shocks, leading to a loss of investor confidence. It can occur within a short period, such as a day or a week.

Stock Market Crashes are often characterized by a sharp double-digit percentage drop in a stock index over a brief period, although there is no strict definition. A stock market drop can have crucial economic consequences, even for the global stock market.

Causes of Stock Market Crashes

Some of the causes of a stock market crash are as follows:

1. Speculative Bubbles

A speculative bubble arises from a sharp increase in asset prices that exceeds their actual value, driven by excessive demand and unrealistic expectations. Prices experience a sharp decline when this bubble bursts, creating panic among investors. 

2. Inflation and Interest Rates 

High inflation has a significant impact on people’s purchasing power, as the prices of goods and services rise rapidly over time. To control inflation, the central bank increases interest rates, making lending more expensive. Furthermore, when company profits decline, stock prices also decrease. As stock prices fall, investors move their money out, which has a greater impact on the market.

3. Leverage

Using borrowed funds to invest in the market is called leverage. Suppose you borrowed money from a friend to invest in shares. You can earn a significant profit during growth periods. But, in case the price of the share falls, you will struggle to repay the loan. To pay the loan, you need to sell the share quickly, which can contribute to a market downturn if many investors do the same, creating panic in the market. 

4. Macro Shocks

A macro shock is an unexpected event with significant economic effects, making it one of the primary causes of a stock market crash. These macro shocks create uncertainty and instability, which affects investor sentiment and corporate performance, resulting in lower stock prices. 

5. Political Environment

From time to time, the government makes policy changes, which can lead to uncertainty in the stock market. Events such as trade disputes and diplomatic tensions often weaken investor confidence and increase market volatility. This can also lead to panic selling of stocks to avoid potential losses. 

6. Market Panic and Herd Behavior

Panic and fear can cause investors to follow the crowd, resulting in herd behavior, where investors sell stocks in large quantities, which pushes prices even lower, worsening the crash. 

7. Tax Regulation Changes 

When inflation rises, the true value of income falls even if the taxable income remains the same. Therefore, the government adjusts taxes to ensure they account for inflation, which can help mitigate the effect. However, these adjustments, in addition to other factors such as recession and rising interest rates, can lower investor confidence and worsen market fluctuations.

Consequences of Stock Market Crashes

The stock market crashes cause pain not only for traders and investors but also spread far and wide to affect many aspects of life and business. Jobs, corporations, savings, and even governments feel the sharp decline in market values. Some of the effects that follow are listed here.

1. Economic Slowdown

Investor confidence can be shaken by a market crash. When the panic hits, companies cut back, and consumer spending takes a nosedive, the economic slowdown that we often call a recession seems to start hitting Main Street in a way that we can see and feel.

2. Banking and Credit Troubles

When stock prices fall sharply, banks and lenders often tighten lending, leading to a shortage of funds. Businesses and individuals may struggle to access credit, which can slow economic growth. In severe cases, financial institutions may face insolvency, as seen during the 2008 global financial crisis.

3. Rising Unemployment

After losing market share and encountering a downturn in sales, many firms respond by laying off employees. Job cuts lead to heightened levels of hiring freezes and unemployment, which often rise quite dramatically.

4. Panic and Fear

Panic spreads among investors when the stock market crashes. They hear the news and get scared about how much more money they’re going to lose. Investors rush to sell, worsening the downturn. By no means are the consequences of a crash confined to the stockholders, either. A lot of people who worry in this situation don’t have any stocks but do have jobs that are affected by what happens to the economy.

5. Corporate Instability

Companies that are publicly held witness a decline in the worth of their shares, which leads some to delay flotation plans, curtail growth, and even discontinue projects. For small businesses and startups, the aftermath of a crash is particularly hard. They find it nearly impossible to raise funds when investors are skittish, and many are forced to implement cost-cutting measures.

Major Stock Market Crashes in India

Over the decades, India has faced major market crashes, from the Harshad Mehta Scam and the 2008 Global Financial Crisis to the 2020 COVID-19 Pandemic Crash. The table below includes all the major events:

* Estimated figures

Different Investment Strategies for a Volatile Market

Markets are never the same. It has its highs and lows, so it is completely normal to feel uneasy about your investments in volatile markets. Knowing how to invest during a crash can help protect your portfolio. Here are a few key investment strategies for volatile markets:

1. Define your investment approach

Having a solid investment approach makes market volatility more manageable. But how do you create your strategy? Where to start from? Don’t worry, we will help you with this. You need to understand and know well about your goals, investment timeframe, and risk appetite. 

Next, your primary goal is to collect enough savings to retire without worrying about money. Lastly, risk appetite shows your broader financial situation, your savings, earnings, debt, and how you feel about it all. You can choose the plan or funds wisely if you know all the above details accurately. 

2. Portfolio Rebalancing

Review your portfolio quarterly or at least annually to ensure your asset allocation aligns with your goals and risk appetite. For example, if stocks now make up 60% of your portfolio but your target is 50%, sell sme equity and increase bonds or other assets to rebalance.

3. Diversification

Spread investments across different sectors, geographies, and asset classes. A conservative investor might allocate: 50% bonds, 30% domestic equities, 10% international equities, and 10% alternative assets. A more aggressive investor could have 70% equities, 20% bonds, and 10% alternatives. Diversification reduces the impact of a single market downturn.

4. Plan long-term Investments

If you are investing to build a huge corpus for the future, it is best to invest in long-term investments instead of short-term ones. Market conditions are never the same; they keep fluctuating. But it has been observed that investing for a longer period has decreased the risk of holding a diversified stock portfolio. 

5. Dollar Cost Averaging (Power of Averaging)

Invest a fixed amount at regular intervals regardless of market fluctuations. For example, invest ₹1000 every month in a stock mutual fund:                       

Month 1: ₹1000 buys 10 units at ₹100 each.
Month 2: ₹1000 buys 20 units at ₹50 each. 
Month 3: ₹1000 buys 40 units at ₹25 each. 
Over time, the average cost per unit is lower than if you invested ₹3000 all at once, reducing the impact of volatility.

The Market Crash Cycle: Bull to Bear Markets

A stock market crash is a part of a cycle that involves a bull market, a stock market bubble, and a bear market.

Market Cycle Flowchart:

Bull markets can lead to a crash, caused by a positive economic outlook and rising stock prices. It can inflate a market bubble when confidence turns into overconfidence. It happens when the prices increase far beyond their actual worth.

Ultimately, it’s too late when investors sense something troublesome with price and reality, panic sets in, and the bubble bursts. Investors get into a hurry to sell off stocks, marking the market crash. It can also result in a bear market, i.e., stock prices are declining and negative sentiment, which can lead to wider economic outcomes, including a recession.

Key Factors to Consider Before Investing

Before investing in any asset, you should be well-educated about certain factors. These factors have a significant impact on financial success. Here’s a detailed checklist to help you make an informed decision:

1. Know Your Financial Situation

• Your Investment Purpose: It simply means: what are you investing in? education, retirement, to buy a home, or wealth growth?
• Emergency Fund: Do you have a few months’ living expenses saved?
• Debt: Pay off your personal loan or credit card debt first.
• Duration: Long-term investments allow more aggressive investing, whereas shorter-term investments need careful handling.
• Risk Appetite: Every investment comes with its own risk. How comfortable are you with market fluctuations and potential losses?

2. Investment Type

Investing in stocks, the things you should research are:

• Start by learning about the basics: what the stock market is and how it works.
• Company fundamentals like earnings, debt, revenue, and growth.
• Type of industry and sector.
• Grab knowledge about valuation metrics like P/B ratio, P/E ratio, ROE, etc.
• Check the stock market chart live to get real-time price data and for technical analysis. You can use platforms like TradingView, Yahoo Finance, etc.

Investing in bonds, the things you should research are:

• Credit ratings from AAA to junk.
• Maturity period and interest rate sensitivity.
• Issuer’s financial strength.

Investing in mutual funds or ETFs, the things you should research are:

• Administrative fees, expense ratio, and other management fees.
• Fund performance history, how it performed in the last 5-10 years. 
• Active vs. passive management.
• Holdings and asset allocation.

Investing in other Investments like REITs, Crypto, Commodities, etc., the things you should research are:

• Regulatory environment.
• Tax treatment.
• Market unpredictability.
• How easily can you sell your assets?

3. Look into Fees and Costs

Check all costs associated with your investments, including:

• Brokerage or commission charges.
• There are expense ratios for mutual funds/ETFs.
• Other expenses like bid-ask spreads, front-load or back-load fees, etc.

4. Study the Tax Implications

• Short-term capital gains or long-term capital gains tax rates.
• Dividends are taxable depending on your income and account type.
• Use IRAs, 401(k)s, or similar options when possible.

5. Invest in Different Assets

• Do not invest all your money in one asset.
• Allocate your investments across different asset classes (stocks, bonds, cash, alternatives), geographies (domestic and international exposure), and sectors.

6. Observe Market Conditions and Economic Indicators

Always keep yourself up-to-date about:

• Changes in interest rate.
• Inflation levels.
• Economic cycles (e.g., recession or expansion).
• Geopolitical events affecting markets.

7. Use the Right Research Tools

Equip yourself with credible information from:

• Financial Platforms like Yahoo Finance, Morningstar, Bloomberg, and Eightcap.
• Read company disclosures such as annual reports, including balance sheet, corporate governance report, profit and loss account, directors’ report, etc., and investor presentations.
• Analyst Reports and Ratings.
• News and Economic Data Sources.

2025 Stock Market Crash in India

In 2025, the Indian stock market crashed, wiping out several lakh crore in just a few weeks. The main reasons were fears about tariffs resulting from Trump’s policies, which caused the rupee to fall sharply to ₹88 per dollar, and a pullout of foreign investors. So far this year, foreign investors have returned approximately ₹1.1-₹1.2 lakh crore (USD 13-15 billion) due to low inflation, yet market uncertainty remains.

The Nifty 50 fell to between 24,700 and 25,100, and the Sensex dropped by hundreds of points. In one session, the BSE lost several lakh crore in market value. Big companies in IT, finance, and exports gave weaker viewpoints or saw their ratings cut. Many investors sold their shares quickly to avoid losses. At the same time, hedge funds and quant strategies that held the same stocks faced sudden losses, which further pushed selling.

Role of Central Banks in Market Crashes

The Central Bank of India – RBI plays an important role in maintaining financial stability and avoiding market crashes through various techniques:

1. Monetary Policy

The central bank uses interest rates and quantitative easing to stabilise the economy and prevent market volatility. For instance, during the COVID-19 market crash in March 2020, the RBI cut repo rates and enhanced liquidity in the banking system to support lending and stabilize markets. They simply lower the rate of interest to boost borrowing and spending, as well as inject liquidity into the market by buying assets to balance asset prices and prevent economic downturns.

2. Lender of Last Resort

During periods of financial stress, the RBI acts as a lender of last resort by providing emergency funding to banks and financial institutions to prevent widespread collapse. In 2020, this included targeted long-term repo operations (TLTROs), which ensured banks had sufficient liquidity to continue lending and support the economy.

3. Regulatory Oversight

Every financial institution has to follow the Central Bank’s guidelines. In India, the RBI supervises the institutions to make sure they have enough capital and are managing risk properly.

4. International Cooperation

The central bank cooperates with other regulatory authorities to manage worldwide risk to the financial system. 

Conclusion

A stock market crash is often a short-term pullback. The best way to survive a stock market crash is to have a clear investment strategy, diversify your portfolio, and remain calm without worrying about assets. Additionally, analysing your portfolio regularly, rebalancing, and staying updated about current market trends can also help you achieve your financial goals. Learn from historical stock market crashes in India to understand how to manage volatility, protect your portfolio, and make informed decisions during market fluctuations.

Stock Market Crash – FAQs