The logic behind the sharp decline in US stocks: How should investors judge and respond?

The U.S. stock market, as a barometer of the global capital markets, often influences the nerves of investors worldwide with its fluctuations. However, many people have not yet understood the fundamental reasons behind significant declines in U.S. stocks and have already fallen into the dilemma of “panic selling” or “blindly bottom-fishing.” To stay rational amid volatility, the first step is to understand: A major drop in U.S. stocks is not sudden but has traceable causes.

The Deep Drivers Behind U.S. Stock Market Fluctuations

U.S. stock market movements are not arbitrary; each sharp adjustment stems from specific economic and political factors. Investors need to develop sensitivity to these factors:

Economic Fundamentals Are the Primary Indicators

Corporate earnings, GDP growth, employment data, consumer spending capacity—these data directly determine the intrinsic value of stocks. When GDP shows negative growth, unemployment rises, and consumer confidence hits new lows, the stock market usually comes under pressure. Especially when the Manufacturing Purchasing Managers’ Index (PMI) falls below 50, it often signals economic contraction, making stock declines unsurprising.

Federal Reserve Policy Shifts

Every rate hike or cut decision by the Federal Reserve affects the cost of capital. High interest rates mean higher borrowing costs, reduced consumer and investment appetite, and pressure on stocks; conversely, the opposite is true. The Fed’s 50 basis point rate cut in September 2024 sent positive signals, but subsequent policy directions still require close attention.

Geopolitical Situations and Market Sentiment

External events such as international conflicts, political risks, and trade frictions can instantly reverse investor expectations. An increase in the VIX fear index often foreshadows deteriorating market sentiment, and investors should remain vigilant at such times.

Lessons from History: Two Major U.S. Stock Market Crashes

The Deep Impact of the 2008 Financial Crisis

The collapse of the subprime mortgage market triggered a global financial crisis. From late 2007 to late 2008, the Dow Jones Industrial Average fell over 33%, and the Nasdaq Composite declined more than 40%. The root cause was uncontrolled leverage within the financial system and accumulated credit risks, ultimately leading to a global credit freeze and economic recession.

The Rapid Spread of the 2020 Pandemic Shock

The COVID-19 pandemic caused intense stock market turbulence within just one month. Between February 19 and March 23, the Dow Jones Industrial Average dropped from 29,551 points to 18,591 points, a decline of 37%. Disruption of global supply chains and a halt in economic activity ignited a wave of pessimism about the outlook.

Both events demonstrate that, whether crises originate from internal financial system issues or external black swan events, market adjustments are often more severe than expected.

How to Detect Risk Signals in Advance

Rather than passively waiting for a major crash, it’s better to proactively identify risk signals. Investors should develop habits of information gathering, focusing on:

Factors That Could Trigger Systemic Risk: Excessive leverage, asset bubbles, and credit risks—any surge in these can become the “last straw” that breaks the camel’s back.

Market Valuation Levels: When the overall market is at a historical high and valuations are stretched, the risk of decline increases significantly. At such times, it’s wise to reduce positions or reallocate into safe-haven assets like bonds and gold.

The Importance of Diversified Investment: A portfolio spanning multiple asset classes, industries, and regions can provide buffers during systemic risks.

The Dilemma After a Major Drop: Sell or Bottom-Fish?

This is the ultimate question every investor faces.

Short-term market movements are unpredictable, and accepting this is the first step. Therefore, investment decisions should not be based on “guessing the next move” but on your long-term investment goals and risk tolerance.

Logic of Selling: Panic selling can prevent further account erosion, but the cost is missing out on market rebounds. Historical data repeatedly shows that rebounds after sharp corrections are often swift. Investors who panic and exit near the bottom often regret being left behind during recovery.

Logic of Buying: Stock prices are often severely undervalued during declines, and high-quality companies’ valuations may revert to levels seen years ago. For investors with sufficient capital reserves and analytical skills, this can be a rare opportunity. However, it requires strong independent judgment to identify true value stocks among many falling prices.

A Middle Ground: Hedging Strategies. When market direction is uncertain, there’s no need to choose strictly between buy or sell.

Using Hedging Tools to Reduce Risk Exposure

For investors holding stocks but worried about further declines, derivatives can be used for risk hedging:

CFD Short Selling

Contracts for Difference (CFD) allow investors to short stock indices at relatively low thresholds. When U.S. stocks continue to fall, shorting indices like the S&P 500, Nasdaq 100, or Dow Jones can generate gains opposite to the spot positions, serving as a hedge.

Leverage Amplification

CFDs support high leverage (often up to 50-200 times), meaning small declines in indices can produce significant short gains, offsetting or partially offsetting losses in spot stocks. Compared to options and futures, CFDs have a lower entry barrier and are more suitable for retail investors.

Caution When Using Leverage

While high leverage can magnify gains, it also amplifies risks proportionally. A wrong judgment can lead to losses multiplied accordingly. Before using any leverage tools, set reasonable stop-loss levels to control single-trade risk.

The Essence of Long-term Rational Investing

No matter how the market fluctuates, the consistent advice for all investors is: Don’t let short-term volatility shake your long-term plans.

The rise and fall of the stock market are essentially a process of continuous revision of market participants’ expectations. No one can predict its short-term direction with 100% certainty. Successful long-term investors typically share these traits:

• Clear investment goals and time horizons
• Calm mindset, not driven by emotions
• Decision-making based on fundamentals rather than technicals
• Regular review and adjustment, avoiding frequent trading

When facing a major U.S. stock decline, the most important thing is not how to double your money in a few months, but how to achieve steady growth through rational analysis, risk management, and long-term compounding. That is the true path of investing.