What Is A Stock Market Correction?

January 23, 2023

What Is A Stock Market Correction?
While many investors fear stock market corrections, they provide investors will ample opportunities to purchase desirable stocks at a significantly reduced price. 

To discover why they occur and how you can take advantage of the opportunities which they provide, continue reading to learn everything you need to know about them.

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 they 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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Types of Stock Market Corrections

There are three basic types of stock market corrections: short term, long term, and final. Short-term corrections usually last between three and six months while long-term corrections often last about one year or more.

Short Term Stock Market Corrections

A short term stock market correction is a drop in the market of 10 percent or less from its 52-week high.

Short term corrections typically happen within a couple of months, and within a year after the market has already experienced growth.

It is normal to experience a short-term stock market correction when there are no other negative factors in the economy.

Long Term Stock Market Corrections

A long term stock market correction is a drop in the S&P 500 Index of more than 10 percent from its 52-week high that lasts for more than two months. This type of correction usually lasts longer than six months, and it indicates that the economy may be experiencing issues.

Final Stock Market Corrections

The final stock market correction is what most investors fear: a drop of 20 percent or more from its 52-week high that last for 12 months or more. This correction indicates that the economy has reached its lowest point and will very likely experience a recovery.

Even though it can be difficult to predict if a correction will be short or long term, it is possible to forecast that a correction will not continue indefinitely.

A stock market correction does not have to result in a bear market, but it can contribute to one. A bear market occurs when the S&P falls 20 percent from its previous high level over a two-month period before August 31. When this happens, investors who are exposed to this risk should consider selling their stocks and seeking more stable investments with less volatility such as government bonds.

It is interesting to note that despite this correlation between severe stock market corrections and historical events including wars or recessions, there does not seem to be a consistent pattern.

What triggers a stock market correction?

Stock market corrections are often triggered by an event that comes as a surprise.

Even though they do not always happen during or after another event, there are some major historical stock market corrections that have coincided with significant events, including:

  • Recession of 2001 - The 9/11 attacks on the World Trade Center caused the S&P 500 to decline 11 percent over the next two weeks, but it bounced back quickly and rallied 22 percent before closing 2002.
  • There were two recessions in 2008-2009 - Both the subprime housing crisis and financial meltdown occurred at about the same time as record oil prices caused inflation to rise above 10 percent. This led to a recession beginning in December 2007 and ending in June 2009. By August 2011, the market had fallen 27 percent to its lowest point.
  • The Great Recession - This recession began in December 2007 and ended in June 2009. However, it is not defined as one single event but rather a combination of several events including the subprime housing crisis, financial meltdown, tightening of credit markets, massive unemployment rates and many other economic factors that led to an extended decline that lasted until March 2009.
  • 2020 Covid-19 Pandemic: 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 corrections in the market. As another example, when oil prices fell overnight in 2014, stock prices remained relatively stable.

What about individual stocks correcting?

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 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 do corrections last?

Well, remember that they are are sudden drops in the stock market, usually caused by an event that causes uncertainty, for example, a terrorist attack or an economic downturn. In 2020 a market correction which was driven by the Covid-19 pandemic, lasted for three whole months.

It can be hard to predict how long they will last because of their unpredictable nature and it's tough to say what could cause one next.

There is no set time frame for how long a correction will last but there are some general guidelines we have found from our research:

  1. They typically occur over the course of 3-6 months
  2. he average length of a correction is 22 weeks (4 months)
  3. They tend to last longer than you expect them to

So to sum up the above, the length of a correction can vary in response to the different factors and events that cause them.

What are the key differences between a stock market correction and a bear market?

Bear Market

A bear market takes place when the stock market experiences a sudden drop of over 20% of its price while a correction refers to a drop between 10% to 20% of a stock market's prior value.

However, some corrections turn into bear markets. For example, in 2007 a 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.

What is the difference between a market crash and a market correction?

  • A stock market crash is a rapid and dramatic decline in stock prices across the board, resulting in a panic and widespread sell-off.
  • A correction does not happen as suddenly as a market crash but instead reflects a downward shift from an unsustainable or overvalued price level.

The difference between a crash and correction is often the result of the size and speed of price movements. If a market drops by 10 percent, it is more likely to be called a correction than a crash. However, if prices fall 25 percent or more in one day, this tends to be referred to as a crash .

A market crash is an extreme but brief (and dramatic) decline in asset prices.

Market corrections involve smaller changes—typically declines within 20% of the initial level of the past 12 months—but they can last longer than crashes; they end when stocks reach their lowest point after falling for at least several consecutive weeks and/or lose about two-thirds of their value from their highest point over the previous year.

In general, corrections are milder than crashes and take place over several months rather than days.

The most severe market crashes are associated with the bursting of asset bubbles (also known as speculative bubbles).

  • October 19, 1987: On "Black Monday," the Dow Jones Industrial Average plummeted more than 20% in a single day.
  • July 17, 1998: The Dow fell 554 points or 7.2%, its largest-ever one-day fall.
  • December 1–10, 2008: This event marks the worst financial crisis since 1929 during the Great Depression. $1.4 trillion in market value was lost when stalls were sold off by investors who'd expected better results after Obama's election.
  • October 29, 2014: During this date, global markets were in a free fall. The Dow Jones Industrial Average dropped over 1000 points in intra-day trading, and the S&P 500 fell more than 5%.
  • January 15, 2018: The FTSE 100 declined by 2% and the S&P 500 dipped 438 points which was an intraday loss of over $1 trillion before rebounding later that day after concerns of further Chinese tariffs on US goods dissipated.
  • January 3, 2018: On this date, the Dow Jones Industrial Average fell 600 points at its lowest during intra-day trading which was part of a drop in global equities.

How often do they 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.

Can you predict them?

I’m sure you have heard the phrase “the market cannot keep going up forever.” What does this mean? Well, as with all things in life, there are ups and downs. This is true for stocks, bonds, real estate, and even currencies (for example the Argentine peso). The question then becomes: how can we predict when a correction will happen? That is what I am here to talk about today.

What are some of the key indicators that will tell us when a correction is about to happen?

Well, there can be many factors contributing to this.

One major indicator has been how much debt we owe on our assets, such as property and stocks.

If you’re reading this article, then it means you invest in stocks - which have had their own crazy ride over the last year but seem like they might finally be settling down for now.

The amount of equity or wealth investors have determines whether someone is willing to take more risk with their investments (such as buying companies with high levels of debt). 

Are there any advantages to them?

It is common knowledge that the stock market can be a risky place for your investments.

This is because there are always ups and downs, which means you could lose money in the long-term if you don't study up on how to best invest.

There are some people who believe that one of the advantages of them is that it allows investors to buy more shares at a lower price.

While this may be true in some cases, it doesn't make sense to ignore all other stocks just because they have dropped in value recently.

Here i'll share three different advantages of corrections and why not investing during these times could cost you a lot of money!

  • Advantage #1 - It allows investors to buy more shares at a lower price: This advantage can help both novice or experienced traders who are looking for smart investments with less risk. Investing on days when share prices are low might give them an opportunity to invest without having as much invested, which means that their total losses would also be less if the company ends up going
  • Advantage #2- It gives time for stocks to recover: A lot of people believe that a correction is the best opportunity they can get during these periods. Stocks are often able to bounce back and increase in value after a period of retracting, so this could be your chance! Investors who buy when prices go low might end up making an even bigger profit than before, which means it pays off to keep investing no matter what side you're on.
  • Advantage #3- Increases trading activity: When investments start dropping in price, investors will have more money available because their portfolio would be worth less but still provide them with enough income to make trades without having as much invested from one company or another.

How to make the most out of one:

Instead of panic selling all of your stocks when there is a dip in the market caused by a correction in the market, 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 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 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.

Final Thoughts

Stock market corrections are perfectly normal and can even be beneficial because they help keep valuations level during periods of intense growth. Even though it might seem like you're taking on more risk by investing in stocks when there's a correction or bear market, this additional risk can actually make you money in the long term. To avoid making a bad decision, your best option is to not panic and sell all of your stocks when you see a correction on the horizon. Instead, do research on why the market dropped and use this knowledge to make intelligent investing decisions in the future.

In our opinion: A stock market correction is a normal part of investing. Whenever there's growth within the stock market, it's typically followed by contraction which causes investors to worry about their investments. Even though it can be difficult to accurately predict what type of downturn might occur, it helps to think about historical events that have changed markets in addition to current news that might affect investors' sentiments.

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About the author 

Jenna Lofton, an expert in stock trading, investing, and financial planning, combines over a decade of experience with rigorous academic training. Holding dual MBAs in Finance and Business Administration from the University of Maryland, Jenna's expertise is grounded in a deep understanding of the financial markets. Her career, which started on Wall Street, has evolved into empowering others through her insights and analyses in the dynamic world of finance.

Based in New York City, Jenna's approach is informed by her hands-on experience as a former financial advisor and her keen observation of market trends. She is known for translating complex financial concepts into actionable strategies, making her a valuable resource for both seasoned investors and newcomers to the stock market. Her commitment to financial literacy and her ability to demystify investment principles have made her a respected and authoritative voice in the investment community.

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