To discover why stock market corrections occur and how you can take advantage of the opportunities which they provide, continue reading to learn everything you need to know about stock market corrections.
What Is A Stock Market Correction?
A stock market correction is an event where the stock market or individual stocks experience an unexpected price drop of roughly 10% to 20% of their value.
Although the average correction involves a price drop of approximately 13% of the original value of a market or stock.
These are way different than a stock market crash. Typically stock market corrections are no reason to be concerned as the majority of the time stock markets and individual stocks fully recover from their price downgrade within a few short months.
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What factors can cause a stock market correction?
There are numerous factors which can cause a stock market correction.
For example if large institutional investors believe that the stock market or individual stocks are overvalued, they may choose to quickly pull their investments.
While institutional investors selling their shares may only cause a dip in the market, historically when everyday retail investors notice a sudden drop in stock prices they typically rush to panic sell their stocks, which causes a full blown stock market correction.
Another key factor which can cause a stock market correction is economic uncertainty. For example, when there was a housing crash in 2008, the uncertainty created by the crash led to a major stock market correction.
For example, the 2020 Covid-19 pandemic was directly responsible for two major stock market corrections.
However, it's important to note that not all economic crises force stock market corrections. As another example, when oil prices fell overnight in 2014, stock prices remained relatively stable.
What factors can cause individual stocks to undergo a stock correction?
Some causes of corrections to the prices of individual stocks include underlying issues with a company's business plan to a company's poor financial performance.
In some cases the failure of a company's CEO and board of directors to appease their investors can also cause an unexpected stock market correction.
On other occasions a stock experiences a rapid drop in price, due to financial analysts naming a stock as being overvalued.
How long does a stock market correction typically last?
On average the impact of a stock market correction will last for four weeks. However, it can take several months for stocks to fully recover from a stock market correction.
For example, in 2020 a stock market correction which was driven by the Covid-19 pandemic, lasted for three whole months.
What are the key differences between a stock market correction and a bear market?
A bear market takes place when the stock market experiences a sudden drop of over 20% of its price while a stock market correction refers to a drop between 10% to 20% of a stock market's prior value.
However, some stock market corrections turn into bear markets. For example, in 2007 a stock market correction evolved into a bear market. Typically bear markets last for 14 to 16 months and have a longer term effect than the average stock market correction.
How often do stock market corrections occur:
Between the end of World War II in 1945 and the start of 2021 there have been 27 major stock market corrections.
Unfortunately, there is no pattern which can predict when the next major correction will take place.
As some years feature multiple corrections while other years remain relatively correction free.
Although it may be useful to note that historically a major correction has taken place at least once per decade. So if you're interested in purchasing discounted stocks during a correction, it's likely that you won't have to wait long for your next opportunity.
How to make the most of a stock market correction:
Instead of panic selling all of your stocks when there is a dip in the market caused by a stock market correction, it's a wise idea to purchase shares in resilient companies which are likely to make a speedy recovery.
As if you choose the right stocks to invest in, you could make a quick profit from your investment.
If you want to be in the right position to take advantage of a future stock market correction, it's a great idea to get into the habit of putting money aside to quickly purchase stocks when the next correction takes place.
As in order for your stock portfolio to make as much profit as possible, it's a great idea to try and decrease the average cost per stock which you purchase and by purchasing stocks when they are cheap, you'll be able to decrease your average cost per stock. As an added bonus, you may be able to afford to purchase a greater number of stocks, while they're temporarily priced below their value.
Just remember that it's crucial to understand the root cause of each stock market correction, so that you'll be able to make financial decisions.
For example, if you believe that there is evidence that a correction could turn into a long term bear market, you may want to hold off on purchasing further shares.
How to decrease your risk as an investor:
There are multiple ways to effectively decrease your risk as an investor. For example, if you work on building a highly diversified investment portfolio which contains numerous different stocks as well as other asset classes, if certain individual stocks decrease in price during a single day of trading, your investment portfolio as a whole will remain healthy.
Also refrain from selling your stocks when they drop as they are likely to recover quickly and you could end up making a sizeable loss for panic selling your stocks.
While it's impossible to predict when the next stock market correction will occur, it's highly likely that the next correction will occur within the next few years.
As historically sizeable stock market corrections have taken place during each decade.
So it's well worth putting your new knowledge to the test and trying to acquire resilient stocks during the next major correction.
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