Things You Need to Know About a Stock Market Correction

Stock market corrections can be severe. At its lowest point in 2023, the Nasdaq composite was down more than 32%, with high-flying growth stocks suffering even greater losses.

 

This is why investors must have a solid plan in place for how they will handle their stock portfolios amid corrections. A buy-and-hold approach can erase years of gains in a short period of time. There is also the important caveat that the beloved stock market leader that is the pride of your portfolio may wind up being a drag on your returns.

 

What do you understand about Stock Market Correction? 

 

A stock market correction is a 10% to 20% drop in key market indices, albeit there is no precise definition of the phrase. Corrections are an unavoidable part of life for investors. In fact, one occurs around once every two years.

 

It's called a correction because a stock market downturn tends to "correct" the market after a time of irrational exuberance by returning prices to their longer-term trend. Corrections can sometimes turn into bear markets, which occur when market indices fall by 20% or more. However, the vast majority of declines have not resulted in bear markets.

 

A stock market correction is a decline in value of at least 10% (but not more than 20%) from a recent high. Investors frequently use the term "stock market correction" to denote a decline in the market as a whole or within a specific index, such as the S&P 500. Individual equities can undergo the same phenomenon, but with much higher volatility.

 

A correction is a drop of 10% or more from an asset's most recent peak. If a stock fell to $90 or lower from its previous all-time high of $100 per share, it would be considered a correction.

 

Corrections can occur in any financial asset, including individual stocks, big market indexes like the S&P 500, and commodities. The S&P 500 dipped below 4,336 in January 2022, representing a more than 10% drop from its high earlier in the year. At that moment, it entered correction territory and sank steadily throughout the year.

 

Also Read | Beginner’s Guide to Stock Market Investment

 

Why does Stock market Correction happen?

 

At its most fundamental level, market corrections (and all other sorts of market falls) occur when investors are more motivated to sell than to purchase. That is basic supply and demand, but it does not explain why investors are selling.

 

Investors are a forward-thinking group. They're trying to figure out whether their investments will increase in value. Investors look for indicators of market movement, such as news, rumors, and everything in between. It changes for several causes, including whether the economy is genuinely faltering, or depending on investors' opinions or emotions.

 

While the reasons for a one-day dip may vary, a longer-term decline is typically caused by one or more of the following:

 

1. A slowing or shrinking economy

 

A slowing or declining economy is a strong, "fundamental" factor for the market's downturn. If the economy slows or enters a recession, or if investors expect it to slow, companies' earnings will fall, prompting investors to sell their stocks. On August 2, 2024, the markets experienced their largest one-day slump since 2022, with all major indexes plunging 1.5% or more. The volatility arose after the United States Bureau of Labour Statistics stated that the unemployment rate for July was 4.3%, a sharp increase from earlier figures. 

 

2. Lack of animal spirits

 

This old adage alludes to the peaks of investor emotion and risk-taking during a bull market. People rush into the market when they see a profit opportunity, causing stock prices to rise. 

 

3. Fear

 

In the stock market, fear is the polar opposite of greed. (And nothing is more effective at instilling anxiety in investors than a 24-hour news cycle that emphasizes how badly the markets are declining.) If investors believe the market is about to fall, they will stop buying stocks, forcing sellers to cut their prices to find buyers.

 

4. Outsized Events 

 

Outside (and outsized) occurrences: This miscellaneous category encompasses anything else that could cause market volatility, such as wars, attacks, oil-supply shocks, and other non-economic events.

 

Also Read | Understanding Key Differences Between Stocks & Bonds

 

How often do stock market corrections occur? 

 

A market correction can be caused by a variety of events, including lower-than-expected earnings reports and volatile political climates around the world, such as inter-governmental trade conflicts. Unexpected events and external shocks, as well as economic downturns caused by these circumstances, can all create market corrections.

 

According to historical data, stock market corrections of 10% occur approximately every 16 months and last an average of 43 days.1 The coronavirus pandemic was remarkable in that it caused stocks to plummet by more than 10% numerous times in a matter of weeks.

 

However, while analysts can attempt to anticipate a correction, it is impossible to know with absolute certainty when a market correction might occur because financial markets are constantly moving up and down.

 

Financial analysts and investors use several charting approaches to predict and follow market corrections. It is difficult to determine when such a correction occurs because the causes range from large-scale economic shifts to financial concerns in a single organization's management approach.

 

A shift in stock market rates during a trading session is bad news for short-term traders, who could lose a lot of money.

 

Conclusion

 

A stock market correction is defined as a loss of at least 10% from a peak and can affect a major stock index such as the Standard and Poor's 500 (S&P 500) or Dow Jones Industrial Average, as well as individual stocks.

 

A stock market correction occurs when the value of equities in a certain market declines dramatically over time. Corrections are usually temporary, although they can last months. They are frequently followed by another increase in share prices. 

 

While corrections can be unsettling for investors, it is vital to realize that they are a natural part of the market cycle. By knowing what causes corrections and how they unfold, traders may position themselves to capitalize on chances throughout this time period.

Stock market Corrections are a regular part of the market cycle, and the greatest thing you can do during a stock market downturn is to stick with it. Stick to your financial strategy and don't allow panic to influence your judgments.

 

Remember that corrections are often short-lived, so selling in the midst of one does little to benefit your portfolio and may potentially lock in your losses. Instead, view a correction as an opportunity to purchase more assets at a lesser cost—and reap the benefits when the stock market recovers.