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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What factors can cause a correction?
There are numerous factors which can cause a one.
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 correction.
Another key factor which can cause a one is economic uncertainty. For example, when there was a housing crash in 2008, the uncertainty created by the crash led to a major 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 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:
- They typically occur over the course of 3-6 months
- he average length of a correction is 22 weeks (4 months)
- 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?
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.
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.
While it's impossible to predict when the next correction in the market will occur, it's highly likely that the next correction will occur within the next few years, as historically sizeable 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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