Stock Market Crash: How to Handle a Market Pullback in Canada

A stock market crash is a sudden and drastic devaluation of a major stock index, like the S&P/TSX Composite Index. Though it can happen alongside global catastrophes and larger economic crises, a stock market crash is often the result of panicked investors selling shares en masse, causing stock values to plummet by double digits. 

With high inflation, a war in Europe, and a supply chain that continues to be clogged, many investors are feeling apprehensive about today’s global markets. Stock market indexes in both Canada and the U.S. have had dismal months in 2022 so far, with brief gains in market rallies getting entirely wiped out by larger market sell-offs.  

If you’re afraid of a stock market crash in the coming months, first, take a step back and breathe. Though crashes can be a stressful experience for a stock investor, they don’t have to be disastrous — you can be prepared. 

Let’s take a closer look at market crashes and find out how you can get yourself ready. 

What is a stock market crash?

A stock market crash is a sharp decline in the market value of stocks, one that happens over a single day or week.

A crash is not a correction, which happens when stocks stumble by 10%-20% from a 52-week high over several days, weeks, and months. Nor is it a dip, which is a fall of 5%-10% from high prices and can happen several times in a day.

A crash is more dramatic than either a correction or a dip, and causes the price of stocks in major indexes to snowball into double-digit losses over a very short period of time.

Why would a market crash?

To put it simply, a market may crash because of a combination of bad news and panic. 

Here’s what usually happens: a catastrophic event — a natural disaster, economic crisis, global pandemic — causes mass panic on the stock exchange. Investors, believing the event will destabilize the financial future of companies, sell their shares to protect themselves from further losses. As more and more investors rush for the emergency exits, supply exceeds demand. This causes prices to nosedive and a crash becomes unavoidable.

A market crash usually comes after a period of sustained growth. When the economy is strong — when unemployment rates are down and traders are feeling optimistic, they’ll buy more stocks, driving prices upward. At a certain point, these prices can become inflated or they represent the over-exuberance of investors. At that point, all it takes is one unexpected event to startle traders and cause the mass panic that brings prices way down.

Is the stock market going to crash? 

The simple answer is yes. The stock market will go through another crash. It’s not a question of “if,” but rather “when.” If you invest long enough, you will face a stock market crash, perhaps more than one. 

Will that crash happen in 2022? Maybe, maybe not. The Canadian economy is certainly undergoing turbulence, and stock indexes have dropped from their 2021 highs. 

Many uncertain events are crushing investors’ hopes for the market, such as the war in Ukraine, rampant inflation, supply chain problems, frequent weather disasters, and climate change. The price of gas, food, houses, cars, utilities, and countless consumer products continues to rise, and the Bank of Canada’s expected prime rate hikes are making it more expensive to borrow. 

Though it’s hard to say whether these factors will cause a full-blown market crash, it’s certain the market will continue to face ups and downs in the near future.

Is a market crash bad?

Stock market crashes aren’t necessarily bad. In fact, you might actually make money in the long run, if you’re savvy and level-headed.

Truthfully, a stock market crash is only as bad as your reaction to it. Sure, no one would say a stock market crash is a pleasant experience, but you only lock in losses if you sell your stocks. If you can resist the urge to sell, you can prevent a bad situation from becoming a verifiable loss of wealth.

What should you do when the market crashes? 

When a crash does happen, you don’t have to throw your hands up and surrender. Here are three ways you can make it through any crash.

1. Refuse to panic-sell

Never, never, never sell stocks out of fear.

Panic-selling is a surefire way to lose money. In fact, selling at prices lower than what you paid is the only way to lose money in the stock market. When you feel the urge to sell, remind yourself that market crashes are typically short-lived and, by staying invested, you’ll get the full force of the market recovery.

Before you sell anything, do your research and make an informed decision. Don’t let emotion take over.

2. Think long term

Make no mistake — stock market crashes are emotional, stressful and heart-wrenching.

Shifting your thoughts from the here-and-now to the future reminds you that the game isn’t over, and you have plenty of time to recover. Turn off the news for a while, resist the urge to check your account balances, and delete your investing apps if you have to.

3. Continue to buy high-quality stocks

Instead of selling, take advantage of the low prices and buy quality stocks. Sure, it’s hard to buy stocks in a crash, especially since you’ll probably experience more losses in the short term. Those who pull the trigger while the market is choppy will likely see generous returns when the market stabilizes.

One way you can stay informed and make wise investments is to sign up for Stock Advisor, where we provide two new stock picks each month and a members’ forum where you can consult with our community of investors during market volatility.

How to prepare for a stock market crash 

It’s been almost a year since we saw the last stock market crash, which was a heart-wrenching 36% drop in the Toronto Stock Exchange. Analysts are already warning another crash is imminent. That can seem a little terrifying, not to mention discouraging, especially if you’re finally picking yourself up after a year riddled with emotional lows.

The reality, however, is no one knows when the market will crash again, no matter what their market analysis says. Nor does it really matter for most investors. You don’t have to know when the next stock market crash will happen to be prepared. Do these things right now and you won’t feel sucker-punched when a crash happens.

1. Build an emergency fund

An emergency fund gives you peace of mind when the going gets rough and it helps you resist the urge to sell stocks and stockpile funds. You should aim to have at least three months’ worth of liquid cash in a secure account.

Note: this isn’t money tucked away in investments or growth-oriented accounts with limited withdrawal access, such as annuities or CDs. Your emergency fund is a stockpile of liquid cash that you can access fast.

2. Rebalance your portfolio

When you rebalance your portfolio, you buy or sell stocks to maintain asset allocation, which is a fancy way of saying you’re balancing risks with rewards.

For example, let’s say you want 65% in stocks and 35% in bonds (this asset allocation would be a less aggressive strategy). Let’s further say stocks go up and your allocation to them rises to 82%. Given the risks of market volatility, you may not be comfortable having that much in stocks.

So, to rebalance, you sell stocks until you’re back to 65%.

3. Make a stock wish list

Which stocks would you want to add to your portfolio if their prices weren’t so high? Start making a list now. Put aside extra cash and when prices are low, see if your dream stocks are affordable.

Similarly, now’s a good time to sell stocks you don’t want anymore. Some companies in your portfolio may have lost their competitive edge, or you may have too many stocks in one industry. Either way, take a close look at your stock portfolio and see what you can sell right now before the market dives.

4. Don’t worry about timing the market

When you time the market, you buy stocks when prices are low and sell them when prices are high. Sounds smart, right?

Truthfully, it’s nearly impossible to time the market correctly and you may find yourself locking in losses and missing out on gains. Instead of trying to time the market, invest consistently. Keeping a long-term perspective and staying invested day-in, day-out, is hands down the best strategy for building wealth.

5. Don’t buy stocks on margin

Buying on margin is an investing strategy that involves borrowing money from a bank or broker to buy stocks. Margin investors will typically combine their own money with a margin loan to buy more shares than they otherwise could. If the stock they buy performs well, these investors can sell their position, repay their broker (plus interest), then pocket whatever profit is left. 

During a market crash, margin investors are often the biggest losers. Not only can they lose their own investment, but they also risk defaulting on their loans. In fact, margin investing was the primary cause of the 1929 Great Depression, during which banks loaned too much money to investors, who in turn could not pay back their loans when stock prices crashed. 

Margin investing is risky, but it’s especially precarious during turbulent markets, such as the one we’re experiencing now. Even if you’re experienced with buying on margin, think twice before you start borrowing money to buy stocks in 2022.  

6. Keep an historic perspective

Lastly, remember: every market crash has a market rebound. No matter how low it dips, the market will recover. No stock market crash has ever, ever resulted in permanent losses. As our buddy Heraclitus said, the only constant in life is change. And yes, that change can be upward.

How to take advantage of a stock market crash 

Savvy investors can take advantage of market crashes by holding on to quality investments and continuing to buy more stock (or more shares of stock you already own).

One tactic to employ during market crashes is dollar-cost averaging. When you dollar-cost average, you invest a regular sum periodically. 

For example, your employer may set aside 5% of your biweekly paycheque into a group RRSP, or you could manually deposit $1,000 into your brokerage account every month. Both of these are dollar-cost averaging, as you’re investing a fixed amount at regular intervals. 

During market crashes, your fixed amount (say, the $1,000) can buy more shares of stock than during the heights of bull markets. For instance, if Stock A cost an average of $500 per share last May, then $1,000 could have bought two shares for the month. If that same stock lost 50% of its value in May this year, then your $1,000 can now buy four shares. That’s the beauty of dollar-cost averaging: without changing your investment contribution, you can buy more stock. 

You might even want to increase the amount you’re investing during market crashes. While that might feel counterintuitive (after all, you’ll likely see a dip in stock price), you could end up owning more shares of a high-quality stock at a lower cost. Then, when the market rebounds, those same shares could produce some handsome returns. 

When will the market recover? 

There’s no way to predict when the market will recover. But we can say this — market crashes are always followed by strong market rebounds. It could take a few months, perhaps even a year, before investors become confident again. But a recovery is bound to happen. And individual investors who stay invested — who continue buying — will be the ones who benefit when it does.  

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a "top stock" is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a "top stock" by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.