The logic behind the decline in US stocks: From historical lessons to investment decisions

The US stock market is a barometer of the global financial markets. Its rises and falls not only reflect the state of the US economy but also influence the sentiment of investors worldwide. However, every downturn in the stock market does not occur out of thin air. We need to understand the underlying mechanisms to make wiser choices when turbulence arises.

Major Historical Crashes: Where Do Risks Come From

Looking back at several significant declines in the US stock market in recent years, we can see the diversity of risks.

Lessons from the 2008 Subprime Mortgage Crisis

During the storm from late 2007 to late 2008, the Dow Jones Industrial Average fell over 33%, and the Nasdaq Composite dropped more than 40%. The root cause was the complete collapse of the US subprime mortgage market, with many banks and financial institutions facing debt defaults. The global credit system froze, plunging the economy into a deep recession. This crisis reminds us: Excessive leverage and asset bubbles are time bombs embedded in the financial system.

Demonstration of the 2020 Pandemic Shock

From February 19 to March 23, the Dow Jones Industrial Average dropped from 29,551 points to 18,591 points, a decline of 37%. Although this drop was sudden, it reflected a global economic standstill—production paralysis, consumption collapse, and surging unemployment. However, this crisis also gave us another insight: Market bottoms are often the best opportunities. The subsequent strong rebound rewarded investors who held firm or took contrarian positions amid fear.

Deep Drivers Behind US Stock Market Declines

To detect signals before risks arrive, it’s essential to understand the four main factors influencing the US stock market:

1. Economic Fundamentals

Economic data is the lifeblood of the market. When GDP growth slows or turns negative, corporate profitability declines, putting pressure on stock prices. Rising unemployment indicates weakening consumer demand. A surge in the Consumer Price Index (CPI) forces the Federal Reserve to raise interest rates, increasing financing costs. A manufacturing Purchasing Managers’ Index (PMI) below 50 signals economic contraction. These data often forecast stock market directions weeks or even months in advance.

2. Guidance from Monetary Policy

The Federal Reserve’s interest rate decisions directly impact market liquidity. Rising interest rates → higher borrowing costs → reduced corporate and consumer spending → market pressure. Conversely, rate cuts have the opposite effect. Recent Fed rate cuts have sent a dovish signal, but investors should closely monitor subsequent meetings for updates.

3. Geopolitical and Policy Risks

International conflicts, trade policy changes, and political uncertainties can directly affect investor confidence. When uncertainty increases, risk assets are among the first to be sold off.

4. Self-Reinforcing Market Sentiment

The VIX (Volatility Index) often signals market turning points when it rises. When investor pessimism spreads, it can create a self-reinforcing spiral—selling accelerates → sentiment worsens → more selling.

Practical Methods to Anticipate Risks

At market highs, taking the following steps can significantly reduce the chance of being caught off guard:

Pay close attention to warning signals. Learn to interpret economic calendars and monitor key economic data releases. When multiple indicators deteriorate simultaneously, stay alert.

Actively adjust asset allocation. At market peaks, consider:

• Reducing stock exposure and increasing cash reserves
• Allocating to hedging assets like bonds, gold, or safe-haven funds
• Diversifying risk across different industries and countries

Learn to use derivatives. When short-term market direction is uncertain, consider risk hedging through Contracts for Difference (CFDs). CFDs offer leverage flexibility and lower entry barriers, suitable for small and medium investors to protect existing positions.

How to Respond After a Decline: Sell or Buy

This is one of the most challenging questions in investing because there is no absolute standard answer—only choices that suit your own situation.

For long-term investors, declines often present opportunities. When high-quality stocks are unfairly sold off due to panic, it can be a good time to accumulate at low prices. However, this requires sufficient analytical ability to identify truly valuable investment targets among many falling stocks, and strong psychological resilience to endure short-term paper losses.

For short-term traders, consider hedging risks by shorting indices. For example, short the S&P 500 or Nasdaq 100 during a market downturn. Since CFDs support leverage up to 200 times, this can theoretically offset losses from stock positions. But high leverage is a double-edged sword, implying higher risks, so use cautiously.

For uncertain investors, the best strategy may be to wait—reduce positions to comfortable levels and wait for clearer signals before making decisions. Avoid rushing into decisions out of panic.

Final Thoughts

Market volatility is eternal; rises and falls are normal rhythms. The true differentiator between successful and unsuccessful investors is not precisely timing the top or bottom but maintaining a long-term perspective and not being misled by short-term fluctuations.

Set clear investment goals, stay rational, and adapt strategies flexibly—by doing so, whether during a major US stock decline or other market turbulence, you can find your own way to respond. The ultimate victory or defeat in investing is never decided at a single point in time but emerges gradually through a series of choices.