What Is a Downswing?

A downswing is a downward turn in the level of economic or business activity, often caused by fluctuations in the business cycle or other macroeconomic events. When used in the context of securities, a downswing refers to a downward turn in the value of a security after a period of stable or rising prices.

Key Takeaways

  • A downswing is a period of poor market performance, or stock performance, following a period of steady or increasing prices.
  • A downswing is usually caused by changes in the business cycle, or broad-based events impacting the economy as a whole.
  • A downswing is similar to a market correction, in which prices drop for a stretch of time after having peaked.
  • Downswings or corrections differ from bear markets, in which the declines accelerate and remain in effect for a longer period of time.

Understanding a Downswing

A downswing is a buzzword that investors use to describe poor market performance, indicating a downward turn in an economic cycle. A natural part of the business cycle, a downswing can be caused by a number of factors.

For instance, a downswing typically occurs when interest rates rise because the higher rates make it more difficult for businesses to acquire financing, which results in less expansion and fewer new companies launching. A downswing will also usually occur after a market has peaked, as the prices of securities begin to decline.

While a downswing provides an attractive opportunity for investors to enter a market, it also carries some risk. Investors with decreased confidence in the performance of the market will be tempted to sell in order to prevent continued losses, and those looking to buy will speculate on the best price before the security or the market begins an upswing again.

Under most circumstances, a downswing in a market is an indicator of a market correction rather than something more substantial. But if the downswing gains momentum and the prices of securities continue to fall, it can be a signifier that a market is entering a bear market.

Downswings and Market Corrections

A market correction occurs in which stock prices drop for a period of time after reaching a peak, usually indicating that prices rose higher than they should have. During a market correction, the price of a stock will drop to a level more representative of its true value. Under typical circumstances, a market correction tends to last less than two months, and price drops are usually only 10 percent.

A bear market, named after the downward motion a bear uses to attack prey, typically lasts much longer than two months. Experts commonly define a bear market as when the price of a major index such as the S&P 500 drops 20 percent or more.

Bear markets occur much less frequently than market corrections. According to statistics, in the last 50 years, only 8 of 36 stock market corrections, as demonstrated by the price performance of the S&P 500, have ended up becoming bear markets. In most cases, the bear market coincided with the onset of an economic recession.