What is a Stock Market Correction? What causes a Market Correction?

What is Stock Market Correction?

Multiple times, we feel like the stock exchange is going under correction. A stock market correction is always around the corner, and investors should prepare themselves for the course correction when the riding gets tough. Apart from this, there is no way a market will send a prior notice of market correction or, in some cases, even if it's a bear market. As a result, it becomes crucial to know about the market correction. 

So let's define what a stock market correction is. It happens when the share market sees a decline of 10% from its 52-week high price. Keep in mind it is a natural cycle that occurs relatively often. Also, one way to predict market correction is by finding if the market tends to be bullish. Truth be told, whenever a stock market correction takes place, it is welcomed by experienced investors. One of the many reasons for welcoming market correction is that it helps consolidate the market before it can reach a new high. 

What Causes a Stock Market Correction?

There are multiple reasons for a market correction. But in most cases, it is because the market is seeing a continuous rise over a long period. This leads excited investors to put their money without adequately understanding the market in the hope of making more money. The stock was being sold to a higher price than its original value, and a market correction occurred to make stocks come back to their initial pricing. On the other hand, a correction in the stock market also results in panic selling, and an experienced marketer will not sell when there is a market correction taking place. 

What are the effects of a market correction?

A market correction is a decline of 10% or more. A correction can last for months or years and can be caused by several factors, including:

• Declining consumer spending on discretionary items (for example, clothing)
• Fear that the economy is slowing down due to decreased consumer confidence in the stock market and other financial markets
• High unemployment rates

Why do market corrections matter?

Stock market corrections are familiar to investors. Long-term stock price drops are a market correction.

Fix errors? Because they help invest. Market watchers say unchecked growth might cause problems for corporations and governments.

Corrections lower share prices (to profit from future gains). Sometimes a company's collapse is so severe that it can't recover financially.

Charting a Correction

A 10% decrease from recent highs is a correction. When the market falls 10%, take heed. A market downturn doesn't always mean a crash, but you shouldn't disregard it.

Check your portfolio to discover if any holdings have declined more than 10%. If so, you're correcting it. The longer the recovery time, the worse for investors in that business or sector.

If you sell when others purchase, you'll have an advantage as a Wall Street insider.

What are Value Stocks During Stock Market Correction?

Truth be told, value stocks are likely to perform better when the economy is on the decline, and the market takes the correction course to save itself. A market correction is quite a good time to invest in value stocks of those companies that has a long-term growth agenda. Over the years, we have seen whenever a stock market of any country corrects itself. The high-value stocks will surely provide you with better returns in times of market distress, and they are also available at a low price at the time of correction. 

But keep in mind you need to properly evaluate the company and understand its growth pattern of previous years. Along with this, you need to look into the quality of your business and management. These two will help you find out the possible endurance of the company before investing money in value stocks. 

How To Invest In Value Stocks When There Is Market Correction?

Value stocks are the ones whose prices are lower than what their company has suggested fundamentally in the first place. With investing in value stocks, you will be looking at a conservative approach which involves buying and holding the share prices of a company even when its price is low compared to the book value suggested by the company. The stock selection depends majorly on two aspects, and these are

Intrinsic Value

The intrinsic value of a stock is based on the fundamentals and the performance of the company over the years. These include the cash flow, how much they are making in revenue, and earnings. In addition to this, there are other varieties of information that include its branding, public image, customer relations, business model, and more. Investor sees the opportunity of getting better stocks when they recognize the stocks are being underpriced. If the fundamentals are robust according to the analysis, there is a certain chance that stock value will undoubtedly see an increase over the course of time. 

Margin Of Safety

The second important concept of value investing is finding the margin of safety. The margin of safety is the difference between the intrinsic value of the stock and its market price. The higher the difference between these two, the wider your margin of safety. Also, it will keep the investor's money somewhat safe when the stocks are not performing as per the expectations. 

Real-World Examples of a Correction

A market correction is when the stock market falls 10% or more from its peak. The most recent correction occurred in February when the S&P 500 fell 6.2%. The Dow was down even further on March 28 before recovering.

The stock market may have been making a comeback since then, but it's still possible for another decline in 2019 that could be classified as a correction.

Preparing Investments for a Correction

• Budget better. It would help if you had an emergency stock market money stolen. If you don't have enough for an emergency fund, save $20 or $50 from each paycheck.
• Reduce debt before investing in volatile stocks or assets (like real estate). Pay off high-interest credit cards first to prevent excessive interest costs. Never borrow so much that a sudden loss in income prevents you from paying for food and housing.
• If feasible, match investments with your goals and risk tolerance level. Someone with a lot at stake may wish to get insurance against price drops during a correction or crash.

How Long Do Corrections Last?

A correction can last anywhere from a few days to several months, with an average length of about 10%. The most extended market correction on record lasted 18 months and occurred between October 5, 2007, and March 9, 2009 (also known as "The Great Recession").

When looking at the history of corrections in the United States, there have only been three times when no correction has occurred: 1993 through 1997, 2002 through 2007, and 2016 through 2019 (so far).

What’s the Difference Between a Correction and a Bear Market?

A stock market correction is a 10% fall over time. A bear market is a two-year fall of 20% or more.

Corrections can develop rapidly and appear unexpected to investors, although they usually last one year (though there have been some notable exceptions). Bear markets are lengthier and less predictable, ending in six months or five years.

Do corrections mark the start of a bear market?

A short-term market downturn is 10% or more, whereas a bear market is 20% or more. Bear markets often coincide with recessions, making economic recovery more complex. Corrections don't always lead to bear markets. Therefore Corrections shouldn't dread them.

Since 1974, only five market corrections have become bear markets.

Since 1974, five market corrections have turned into bear markets. The average correction lasted ten months, and the most extended correction lasted 19 months. The shortest correction lasted three months.

But what if it is the start of a bear market?

Uncertain when the slump ends and the bull market resumes. There are ways to tell. A bear market is a long period of falling stock prices, not one lousy week. When high volatility causes stock price drops and quick recoveries, corrections occur. Bear markets need patience. Suppose you don't have enough in your 401(k) to weather market volatility without paper losses (or worse).

Conclusion

Well, that's about it for market correction; the term stock market correction seems a little scary. But we hope this blog is able to tone it down and make you understand how to make use of it with your knowledge. If there is one thing we want you to follow is that you should not be completing any form of impulsive decisions based on the factors of market decline. 
With the understanding of stock market correction, you are in better shape to fully comprehend the importance of your shareholdings and manage them in a much better way now when there is a market correction taking place.