What is Stock Market Correction?
Ever heard of a “market correction”? A stock market correction means when the prices of things like stocks or other assets take a bit of a dip. So imagine you’re playing a game, and you’re doing really well, but then you hit a small bump – that’s a correction.
Usually, it means the value of a stock or an entire market, goes down by around 10% to 20% from a high point. This can happen to big stock groups like NIFTY 50 or IT company shares. So, let’s dive into what is stock market correction all about.
What is Stock Market Correction?
“When you say ‘market correction,’ some folks picture a big crash, but it’s more like a market taking a short break.”
-Joseph Hogue, a former Wall Street pro
A stock market correction meaning is when the prices of stocks, which are like pieces of different companies, slow down or take a little dip after they’ve been going up for a while. It’s usually kind of like the stock market saying, “Hey, let’s take a breather before we zoom ahead again.”
This may happen because the stock market is like a big group of people buying and selling stocks. Sometimes, these people can feel like stocks are getting a bit too expensive, so they start being a little more careful with their buying. This may result in the prices of stocks going down a bit, which is the “correction” part.
In the past 30 years, the Nifty 50 has experienced more than 19 corrections and is currently down by approximately 14% from its all-time peak.
Why Does Share Market Correction Occur?
First off, think about how the economy works. When things are going really well, like when everyone is buying lots of things and businesses are making good money, the prices of shares go up. But sometimes, things slow down a bit. People might not spend as much, or businesses might not make as much profit. When that happens, share prices can go down a little. It’s like a roller coaster taking a small drop.
Then there is investor emotions. Yes, how people feel can play a role too! If investors start to worry that the prices are too high and might not stay that way, they might start selling their shares. This can make the prices go down even more.
Lastly, what’s happening in other parts of the world can also affect our share market. If something goes wrong in a different country or if something unexpected happens, it can make investors nervous. They might decide to sell their shares, which can cause prices to drop here too.
How to Identify a Stock Market Correction?
Financial analysts and investors utilize various charting methods to assist in forecasting and monitoring market corrections. Analyzing when a correction occurs can be complex, given the diverse range of factors contributing to it, ranging from broader economic shifts to specific issues in a company’s financial management strategy.
Sudden fluctuations in stock market prices within a single trading session can pose challenges for short-term traders, potentially resulting in substantial financial losses during such periods.
Therefore, predicting market corrections is a challenging task, and even experts find it inconvenient to pinpoint the initiation and conclusion of such declines in stock prices.
How Long Do Stock Market Corrections Last?
The duration of major stock market corrections can vary, but they typically last for a relatively short period of time, ranging from a few weeks to a few months.
According to Ed Canty, CFP, a financial planner at CFM Tax & Investment Advisors, corrections are not consistent in terms of their duration. For instance, during the Covid-19 pandemic, the stock market correction in February and March 2020 lasted approximately three months. On the other hand, the correction trading experienced in September 2020 was much shorter, lasting only about three weeks. This highlights that corrections come and go, each with its unique timeline and characteristics.
What are the Causes of Market Corrections?
There are many factors that can cause market corrections. Some of the most common causes include:
- Economic Factors: A slowdown in economic growth, rising inflation, or a trade war can all lead to market corrections.
- Political Factors: A change in government, a natural disaster, or a terrorist attack can also cause market correction.
- Negative News: A negative earnings report, a product recall, or a scandal can all cause investors to sell stocks.
- Technical Factors: A stock market bubble can eventually lead to a correction as investors take profits.
- Overvaluation: If stocks become too expensive, investors may start to sell them in order to lock in profits.
What are the Factors to Consider in Market Correction?
While stock market corrections might seem unsettling, they don’t always signal trouble. It’s essential to weigh various factors that reveal both the upsides and downsides of stock price corrections.
- Short-Lived: Investors may assess whether the correction in market is short-lived or has a lasting effect on the market. Some market correction trading may only affect the market temporarily, while others could have more enduring consequences.
- Affected Personnel: Consider how different groups of people, such as investors, consumers, and businesses, can be affected by the stock market correction. Understanding its implications for various stakeholders can provide valuable insights.
- Long-Term Investments: Evaluate how the correction in stock market works and may influences long-term investment strategies. Some stock corrections might necessitate adjustments in long-term portfolios, while others may have minimal impact.
- Market Sentiment: Analyze investor sentiment and behaviour. Fear-driven selling can exacerbate a stock market correction 2022, while rational decision-making can mitigate its impact.
How to Prepare for a Market Correction?
Preparing for stocks market correction involves taking certain steps to protect investments and financial well-being. While there are no guarantees in the financial markets, here are some strategies you may consider to help you be more resilient during a potential correction:
- Diversify Your Portfolio: Spreading your investments across various asset classes, such as stocks, bonds, real estate, and commodities, may help reduce risk during a market correction.
- Rebalance Your Portfolio: Regularly review and adjust your portfolio to maintain your desired asset allocation. Rebalancing can help ensure you’re not overly exposed to volatile assets.
- Build a Cash Cushion: Having some cash on hand may allow you to take advantage of buying opportunities during a correction. Cash can provide flexibility when prices are more favorable.
- Set Stop-Loss Orders: If you’re concerned about specific holdings, you may consider setting stop-loss orders on individual stocks or investments. This can automatically trigger a sale if a certain price is reached.
- Limit Margin Trading: Using margin to leverage your investments can magnify losses during a correction. You might want to consider reducing or eliminating margin trading.
- Avoid Panic Selling: In a market correction, emotions can run high. While it may be tempting to sell in a panic, this could lock in losses. Stay calm and stick to your long-term investment plan.
- Evaluate Your Risk Tolerance: Review your risk tolerance and make sure your investment strategy aligns with your financial goals. Adjust your portfolio if needed.
Time Correction vs Price Correction
Let’s have a look at the differences between time correction vs price correction.
| Feature | Time Correction | Price Correction |
|---|---|---|
| Definition | A prolonged period of stagnant prices where the security trades within a relatively narrow range. | A temporary decline in security prices, over a short period. |
| Price movement | No significant change in price, either upward or downward. | A downward movement in prices. |
| Duration | Typically longer than a price correction, often lasting for months or even years. | Usually shorter than a time correction, often lasting for weeks or days. |
| Causes | Lack of growth, excessive price appreciation, or market consolidation. | Economic factors, geopolitical events, or investor sentiment shifts. |
| Investor behavior | Requires patience and a long-term investment horizon. | May require active trading or rebalancing strategies. |
What’s the Difference Between a Correction and a Bear Market?
Among the general public, a common error often occurs when distinguishing between a market correction and a bear market. The latter may signify a decline in the economy.
(To understand the differences between two types of market trends, read our blog on Bear vs Bull Market)
To classify a market as bearish, a decline of 20% may be required, whereas a market correction may occur with a 10% decrease in stock prices. Therefore, let’s have a look at the following table.
| Feature | Market Correction | Bear Market |
|---|---|---|
| Definition | A decline of 10% from a recent peak | A decline of at least 20% from a recent peak |
| Duration | Usually lasts for a few months | Can last for several months or even years |
| Causes | Typically caused by a combination of factors, such as economic slowdown, rising inflation, or political instability | Typically caused by a more severe economic downturn or a loss of investor confidence |
Impact | Can cause losses for investors, but is usually temporary | Can cause significant losses for investors and may take several years to recover from |
| Recommended Action | It’s advisable to stay calm and avoid panic selling | Investors may consider selling some of their riskier assets and moving to safer investments. |
What Should I Do During a Stock Market Correction?
Maintaining a diversified and disciplined strategy may often lead to success by staying steady through a stock market correction. Therefore, investors can benefit from minimizing emotions and relying on logical decisions.
And if you do find yourself in the midst of a correction stock market, which invariably all of us will, here are some ways you might want to consider.
Understand the Cause
First things first, pause and figure out why this stock correction is happening, says Hogue. It could be long-term job problems or more people not being able to pay back loans. Or it could be something specific like a company’s earnings report not looking good.
If these changes are affecting the bigger stock market, it might be a hint that a bigger stock market correction or even a bear market is coming. But hang on, it doesn’t mean you need to start selling your stuff.
Create a Portfolio that Matches Your Comfort Zone
Getting proactive with your investments before a market correction can be a smart move, according to Canty. It’s advisable to shape your portfolio by picking assets that may suit your goals and how much risk you’re okay with.
This way, you’re less likely to let your feelings guide your investment choices when a correction in share market comes around. But hold on, don’t switch up your investment game during a stocks market correction. That’s how folks in aggressive portfolios end up locking in losses.
Hold Cash for Opportunities
“In more than 100 years of stock markets, the truth is prices tend to go up again, so try not to take your money out when prices dip.“
A smart move in investing might be to have enough cash saved up to handle ups and downs without using your invested money. It is better to have an extra stash just in case things go down, so you can buy more when they do. If prices go down, you can actually make the most of it by investing a bit more each month, getting in at lower prices.
Regularly Review Your Risk Profile
The amount of risk you’re comfortable taking with your investments might change over time. As you may get closer to retirement and actually retire, you might want to have fewer stocks in your investment mix to lower the risk.
By having the right mix of investments for your age and comfort with risk, you can let your stocks do their thing during a stock market correction. They can bounce back while you use your other money until things improve.
To Wrap It Up…
To conclude, a market correction isn’t as scary as it sounds. It’s like a little adjustment in the roller coaster ride of investing.
Thus, it’s important to know that these corrections are just a natural part of how things work. That’s why it is advisable to stay careful when investing during uncertain times. By staying informed and taking a cautious approach, you can steer clear of unnecessary financial bumps and enjoy a smoother investment journey. Additionally, please do your own research and/or consult a financial advisor before investing.
FAQs
A market correction is a decline in stock prices of at least 10% from a recent peak. Market corrections are a normal part of the stock market cycle and can happen for a variety of reasons.
A market correction is named so because it’s a ‘correction’ or ‘temporary’ adjustment to stock prices, bringing them back to more reasonable levels after they’ve gone up too fast or too high.
It is possible to lose money during a market correction, but not guaranteed. This depends on the size of the correction and your investment portfolio. You can invest in defensive stocks to avoid losing money during market corrections.
Market corrections aren’t strictly positive or negative. They signal a market’s self-adjustment after growth, yet can reflect deeper issues. The impact varies based on investor factors and risk appetite.
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