What is Stock Market Correction?
Stock market correction meaning in stock markets refers to a dip or rise in the stock market index generally by a minimal 10%. After a stock market index has risen steadily for a long period, a market correction is usually viewed as a healthy pullout before the index continues to rise.
Market corrections can help readjust asset prices that have become unsustainable. Corrections in the market are typically short-lived, lasting about four months on average. Let’s learn more about this so that you can make informed investment decisions.
What is a Market Correction?
Market correction in terms of finance and investment refers to the change in trend, visible as a change in direction of the indexes as the stock prices move from their current market high or low.
A market correction occurs when there is a 10% or more increase or decline in the price of securities, including currency markets, stocks, indices, and other assets which you can trade on the exchange market.
While these securities are prone to falling into a correction for days, weeks, months, or even longer periods, recent financial analysis states that market corrections are usually short-lived, the duration ranging for not more than three to four months.
What Causes Stock Market Corrections and How to Identify Them?
Stock market corrections are often witnessed when any event leads to mass interest in the stock or a panic selling of stocks. Financial experts and professional investors advise you to avoid selling during market correction as you might never get the opportunity to make up for the losses you incurred.
Traders, of course, want to make use of every opportunity to earn potential profits, a stock market in a bullish run is perfectly primed. This often leads to irrational volatility as activity suddenly picks up pace.
Eventually, it leads to an increase in stock prices more than the inherent value of the stock, and stock market correction occurs. The converse is also true where a stock market correction happens on the downside when prices start returning to their normal levels.
But that’s just one situation. Several reasons can cause a share market correction. These reasons include interest rate changes, political and economic policy changes or issues at domestic as well as global scale, calamities or war situations that call for global reactions, pass-over effect, or domino effect of an impact on other assets such as commodities or currencies, etc.
Even individual company news can trigger stock market corrections. Furthermore, it’s nearly impossible to anticipate the stock market correction coming.
Financial experts use several charting methods to anticipate and monitor market corrections. However, it’s quite challenging to analyse and pinpoint the exact moment when a stock correction may occur.
A rule of thumb when investing in the stock market is to always be wary and watch out for triggers that may set off market movements. However, one need not necessarily react to the changes instantly, especially with stock market investments.
As a market tends to correct downward, it shall also be correcting upward, and the journey of markets has always been upward in the long term. This is why most analysts and advisors push investors to save for the long term.
“Buy the dip” is a very common phrase in stock market circles, which means that when a stock market is correcting downward, instead of panicking, it may be a good time to enter the stocks. Enforce caution!
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Also Read: Stock Market Index – Importance, Need, Types & Selection
Why do Stock Market Corrections Happen?
A plethora of factors are responsible for causing the stock correction. These factors include rising inflation, global economic changes, slow-down of economic growth, global health crisis, changes in monetary policies, volatility of the market, political developments, and more.
As a result of a critical mass of investors selling off their shares, more investors get into the sell-off mode. Plunging crude oil prices, wars, sanctions, terrorism, and pandemics are all global triggers that can cause panic selling, eventually leading to a market correction.
How to Prepare for Stock Market Correction?
You can follow the below steps to prepare for the stock market correction coming in the future:
Step 1: Define your investment goals
You must always have a definite plan for your investments, regardless of whether the stock market is in correction. When you have an idea of which investments you want to hold in the long-term, you shall have some assurance. It prevents you from acting on impulse during market fluctuations.
Step 2: Evaluate the diversity of your investment portfolio
A market correction can impact investors differently, depending on their investments and financial strategies. Investors with short-term investments shall feel the impact of market corrections more severely compared to those who have a long-term approach to investing. Furthermore, if you have long-term investments, your securities shall have more time to recover from market corrections. A diversified investment portfolio strategy also works to alleviate effects of stock market corrections.
Step 3: Take action when and where possible
There’s just no perfect time to act when you are dealing in the stock market. However, you can take steps to mitigate your losses and prevent losing value altogether. Traders can use stop-loss-order to reduce their exposure to risks.
Step 4: Closely monitor the stock market
You can use an investment tracker to evaluate your stock’s performance. Moreover, when you are up-to-date with market conditions, you can tailor your investment plans ahead of time and better accommodate market fluctuations.
Step 5: Don’t rely on market predictions too much
You shouldn’t buy or sell too many stocks depending on market predictions. Always ensure you have considered the long-term impacts before you make any major financial or investment decisions.
Pros of Investing During Market Correction
Here are some of the most prominent benefits of investing during a market correction:
- Most stock corrections in the market are short-lived. If investors proceed with caution, they can easily pass through the period.
- A market correction brings excellent opportunities to buy securities at lower prices.
- A stock market correction does not have severe impacts on long-term financial strategies or investors who diversify their investment portfolios.
Cons of Investing During Market Correction
Despite being short-term, market correction can have several drawbacks for investors: The disadvantages are listed below:
- Market correction may be a precedent to a bear market. It is the beginning of a bigger problem, such as a bear market with a recession.
- It negatively impacts short-term investors with a sharp decline in values.
- It can also severely impact income-generating investments.
- It often causes panic among investors, leading to the liquidation of many securities – basically panic selling.
Market Correction vs. Bear Market
The terms market corrections and bear markets are often interchangeably used. A bear market refers to a falling market and economy. In the bear market, stock prices keep falling at a steady rate.
A steep decline in stock prices over a longer term is considered to denote a bearish market. However, when the stock market is in correction, there is a deviation from the existing trend or generic direction the market has been taking; it can be a positive correction or a negative correction too.
Also Read: What is EPS in Stocks and Why is it Important?
Final Word
A market correction refers to a trend reversal in the stock market. A stock that has become overpriced may see rates coming back down to regular levels, or a stock that has been beaten down may see an uptick. A correction is generally a good time for investors to pick up new assets. However, one should exercise caution when dealing in the stock market as a stock market correction on the downside may also lead to a bear market should the correction be long drawn.
FAQs on Market Correction
Ans. During a bear market, the aggregate cash flow is insubstantial. Eventually, it leads to a significant decline in the demand and supply in the economy. A bear market hampers global economies and may trigger recessions. However, a market correction is an automatic price adjustment to the currently trading stock price. It does not really have any immediate effect on the economy directly, but improving stock market generally spells good news for the economy.
Ans. A stock market correction can last from a few days to weeks or months. However, the average stock market correction can last between 3 and 4 months. According to CNBC and Goldman Sachs, the estimated losses in the stock market stand at 13% during the four months of market corrections. This year’s stock market decline has been dramatic as it has fallen by almost 20% along with other major indexes.
Ans. Market corrections are quite often in the stock market since the factors contributing to the same are plenty and inevitable. The market corrections occur after every bull market or bear market, or when stock prices have become over priced or undervalued and there is a trend reversal. Market corrections are a common phenomenon.
Ans. If you want to take advantage of lowered stock prices with the intention to earn profits when the market recovers, you can invest during stock market corrections. It is important to note that selling during a market correction could lock in your losses and tank your portfolio.
Ans. You may opt for assets allocation, invest in safer securities, and have a long-term perspective on your investments to deal with market corrections. Market corrections are the best time to invest in shares. However, one must analyse the trends before making their move.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
