What Are Market Corrections and Should They Startle You?
Market corrections can startle short term investors and could sometimes lead to bear markets, but they are also needed to sustain a bull market.
When studying the stock market you often hear of market corrections. Corrections are adjustments to the market that help sustain a bullish period. While people’s interpretations vary slightly as to how much a correction can extend to, in general definition a correction is considered to be a decline of 10% or more in a security’s price from its latest peak. These kinds of adjustments can happen in stocks and indexes as well as commodities and currencies.
This correction could be for just days or even extend to weeks and months. Sometimes it could be for a longer period too. Market analysis can project corrections. You can also find corrections by comparing a market index to another similar market index. By comparing, an analyst could detect an index that’s underperforming. An underperforming index could be closely followed by another similar underperforming index. If this trend is steady, it is an indication of a potential market correction.
Before a market correction you’ll find that individual stocks could still be strong. They could even be over-performing. When a correction comes though, the adverse market conditions could result in individual assets performing poorly. That’s why corrections are considered the ideal time to acquire some high-value assets since they’ll be available at cheaper prices. That is a strategy you can adopt with the hope of prices of these stocks rising once the correction is over, provided you are capable of accommodating any risk involved.
Why Market Corrections Can Be Good
Going back to the point we made earlier, corrections are considered a healthy phenomenon for the market. Corrections enable readjusting of the asset valuations when they reach an unsustainably high level. Corrections can recalibrate these valuations. Investors too can benefit from this, as a result of the discounted prices of these assets, as we discussed above. These corrections also give them reminders of the rapidly changing nature of market environments.
However, corrections can startle investors, particularly novice investors. A downward adjustment of 10% or more to their assets could be extremely stressful since they would not have experienced anything like this. The alarm bells of doom would ring. But this article should calm your mind when situations like that arise. Market corrections, on average, only last between 3 and 4 months.
Corrections Could Lead to Bear Market Too
Not all corrections change back to a bull market though. Investopedia’s James Chen points out that in the 36 corrections experienced in the US markets from 1980 to 2018, ten of them brought about bear markets, indicating a downturn in the economy. The rest of the corrections resulted in bull markets, indicating economic growth.
Even as recent as February 2018, we saw the S&P 500 index and the Dow Jones Industrial Average (DJIA) experiencing corrections. They dropped by over 10%. And in October 2018 the S&P 500 and Nasdaq went through corrections. The following chart by TradingView.com, quoted by Investopedia, depicts the corrections that affected the S&P 500 in the context of 2017-2018.
Why Corrections Prove the Advantages of Long-term Investing
The stock market corrections are a concern only if you’re a short term trader. Such traders have aims focusing on the short term, and corrections could affect their investment goals and plans. They also use margin to leverage their account heavily. That could cause the losses to be exemplified during a downturn. Day traders too would find their losses flaring up in a correction. Taking this into consideration, corrections remind us that long-term investing is less risky and more reliable in terms of the results it can give you. That has been proven in history.
Online trading brokers have made stock trading a lot popular, with the more advanced ones offering user-friendly direct access trading platforms. But succeeding in the stock market requires you to have a significantly insightful understanding of how the market works.
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