What is a stock market correction?
A stock market correction occurs when an asset's price falls 10% or more from its latest high. It can affect any asset traded on the exchange, including stocks, indices, currencies, or commodities. At times, even an entire stock market could experience a state of correction. It may last days, weeks, or months. Typically, correction is a temporary episode observed for three to four months (approximately).
What causes a stock market correction?
Several factors can result in a stock market correction, such as negative news, economic upheavals, policymaking, or global crises like the COVID-19 pandemic. As they are influenced by uncontrollable aspects, corrections are difficult to anticipate. Such events can, therefore, stimulate a sense of unease about the future among investors, triggering a frantic selling of stocks in exchange for assets that are considered to be comparatively safer.
Interestingly, corrections can be seen as beneficial pullbacks in the case of stock market indices that have been enjoying consistent growth for a long time. Before the indices thrive again, market corrections can help by recalibrating valuations of assets that have reached unsustainable levels.
Additional read: Invest in stock market
How to identify a stock market correction?
As mentioned earlier, predicting stock market correction is somewhat tricky as their manifestation is governed by economic shifts of scale or colossal financial setbacks of one organisation. However, analysts and investors usually rely on technical charts to monitor them.
When the market is gripped by stock correction, you must remember the following factors to avoid any irreversible mistakes.
- As compared to bull or bear markets, corrections last for a much shorter period, i.e., three to four months.
- While market corrections may seem like a rare occurrence, especially to new investors, they are routine phenomena in capital markets that emerge to readjust asset prices.
- In most instances, market corrections end up affecting short-term traders. If you are a long-term investor, these interim fluctuations would not make much of a difference to your portfolio.
- The period of correction can prove to be a lucrative opportunity for acquiring stocks at a bargain that are otherwise expensive. Investing in such high-end stocks can help you earn capital profits in the long run.
Additional read: Stock exchange
How to deal with stock market correction?
To evade any financial setbacks, most investors react to the inflated market by hastily buying and selling stocks. Alarmed by the possible repercussions of a market correction, they tend to fail to retain their long-term investments and make the mistake of surrendering stocks during inopportune periods, which only leads to unnecessary losses.
When a correction materialises, it will impact all equities. However, instead of falling prey to the widespread panic, you must prepare to face this event with the following techniques to protect your fiscal interests.
Asset allocation: A financial planning tool, asset allocation enables you to mitigate risks and maximise rewards by diversifying your investments across multiple securities. By adopting this strategy, your wealth is distributed in stable options, shielding you from major downturns like a correction.
Lock-in investments: The outcome for long-term investments during market corrections is generally favourable. This is because market corrections are short-lived, only producing losses for intraday trades. To prevent rash decisions, opt for lock-in periods, which can safeguard your investments while the markets bounce back.
Government securities: Investing in government securities is a clever move as the innate value of such assets does not sway with the price movements of the market. Additionally, they possess the assurance of principal and fixed interest rates. You can choose to allocate your money to such instruments, particularly if you are unsure about investing in the capital market during the correction period.
What is the difference between a stock market correction and a bear market?
The distinguishing aspect between a stock market correction and a bear market is the extent of the decline. While a correction only suffers from a decline of 10%, a bear market starts from a minimum decline of 20% from the latest peak. Furthermore, bear markets are shown to last longer than corrections because they are triggered by serious economic hardships such as recessions and not due to short-term setbacks or trends. For most analysts and investors, the challenge is to differentiate a correction from a bear market in real time. But, this can only be ascertained after a considerable time has passed.
Additional read: Stock options
Closing thoughts
Stock market corrections can be intimidating as they reflect a downtrend, leaving the investors in a state of panic, causing them to buy or sell assets unreasonably. However, they make routine appearances in all economies and are not as alarming as they are made out to be. As a responsible investor, you can comfortably weather the choppy waters of corrections by taking simple measures. These include diversification of your portfolio, locked-in investments, and utilisation of government securities.
