What is a ‘Correction’
A correction is a movement, almost always temporary and happening in reverse, that accounts for at least a 10 percent adjustment to fix the overvaluation of a stock, bond, commodity or index.
BREAKING DOWN ‘Correction’
A correction can usually be predicted during an analysis, and by comparing one market index to a similar market index. Using this method, an analyst may discover that an underperforming index will be followed closely by a similar index that is also underperforming. A steady trend of these similarly slowing indexes may be a sign that a market correction is coming.
When a market correction occurs, individual stocks may still be strong, or even overperforming. Conversely, during a correction period, individual assets may still be performing poorly. Market corrections are thought to be a perfect time to pick up high-value assets at discounted prices for aggressive investors with available capital.
Although market corrections can seem challenging and a 10 percent drop may be significant for larger investment portfolios, market corrections are good for both the market and for individual investors. Considering how volatile the stock market can be with many short-term changes happening rapidly, over the long term the market remains quite stable. This gives short-term, or casual investors, a brisk introduction to how quickly the market can change. Investors then decide how comfortable they are with making large investments when the market may shift in an instant. More seasoned investors, or those who are familiar with the ups and downs and inherent risks in the market, have the chance to take advantage of discounted prices.
Market Corrections in the News
Corrections to the market happen often. In February 2018, two major indexes, the Dow Jones Industrial Average (DJIA) and the S&P 500 both experienced a correction. Both indexes dropped by more than 10 percent.
Between 1980 and 2018, the U.S. markets experienced over 36 corrections. During this time the S&P 500 had fallen by an average of 15.6 percent. Ten out of 15 of these corrections resulted in bear markets, which are generally indicators of economic downturns. The others remained or transitioned back into bull markets, which are generally indicators of times of economic growth or stability.
The average market correction is short lived and lasts anywhere between three and four months. While that may not seem like a long time in the grand scheme of things, it is easy to see why a more casual investor may be worried by a 10 percent or greater downward adjustment to their assets during this period, especially if they are new to investing and this is the first correction they’ve experienced.