Table of Contents
A stock market correction occurs when the market hits a new high, and then falls by at least 10%. A correction is similar to a dip or crash, but not as severe as a “bear market,” which is when the market sees a decline of 20% from a recent market peak.
Stock market corrections are normal and it’s important to be aware of why they happen and what you might consider doing the next time the market sees a correction.
Key Points
• A stock market correction is a 10% drop from a recent peak.
• Corrections are a normal part of the market cycle.
• Remaining calm and reassessing the portfolio is advised.
• Diversification and a long-term strategy can help manage volatility.
• Cashing out and buying more during downturns can be advantageous, though risky as well, as it’s a form of trying to time the market.
What Is a Market Correction?
A stock market correction happens when the market reaches a new interim high and then falls by 10%. Some other stock market terms for market downturns include dips or crashes, which may be temporary or quick drops in the market that don’t see the market fall past 10%.
Corrections vs Bear Markets
A bear market is a longer decline in the stock market, and refers to the market after it declines 20% or more from a previous high. These terms can also apply to individual stocks (“Stock X is in correction territory,” for example), but individual stocks can see much more volatility than the overall market.
The most severe stock market correction in history, in terms of points, happened in 2018, when the Dow declined 1,175 points in a single day. Previously the record had been a 777-point decline.
However, the 2018 4.6% drop wasn’t the biggest decline in terms of percentage. In 1987, on a day called Black Monday, the Dow dropped by 22.6%. That would be equivalent to 5,300 points in today’s market.
Market Correction vs Market Crash
It can be tempting to use the terms “crash” and “correction” interchangeably, and sometimes, that may be appropriate. But in a more general sense, a “crash” refers to a more sudden and drastic fall in the market. Whereas a correction may occur over weeks, a crash could happen within a single day or days.
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The Nature and Frequency of Market Corrections
Stock market corrections happen every once in a while. They are, in fact, a normal part of the market cycle. That’s important for investors to keep in mind, as it’s not unusual at all for the market to experience a correction.
How Common Are Market Corrections?
Dating back to the mid-1900s, stock market corrections have typically happened three to four times every year. Although it’s nerve-wracking every time, these corrections are a normal part of the market cycle, as mentioned.
Duration and Impact of Corrections
When a correction occurs, you will likely see the media speculate whether it’s a crash or a correction, how long the correction will last, and perhaps, if the economy is going into a recession. This speculation is just that; there is no way of knowing exactly how big a correction will be or how long it will last.
A stock market correction is not typically the cause of a recession, nor is it a predictor of a coming recession. Stock market corrections can be stressful for investors and companies, but they are not necessarily signs of a poor economy.
Although there is no way of predicting how long a market correction will last, you can look to past data as some indicator of possible trends.
Average Market Recovery Time After Corrections
While corrections can happen quickly or play out over a prolonged period, a full recovery generally happens within a few months, per past market data.
Navigating Through Market Corrections
Given that market corrections are common, investors would do well to know how to handle them. That may or may not involve making any changes to your portfolio.
Preparing Your Investments for a Correction
Unless you exclusively own stocks in an S&P 500 index fund, your portfolio may perform differently from the overall market. When a stock market correction occurs, the percentage drop is generally referring to the performance of the S&P 500 index. This is an index of the largest U.S. companies in the stock market.
The stocks in your portfolio may fall in value more or less than the overall market. Some of your stocks may even go up in value. It’s important to remember that if your portfolio drops by a certain percentage, it will need to go up more than that percentage to recoup your losses.
Strategies for Investing During Corrections
Generally, a good rule of thumb is to stay invested through a market correction — or, stick to a buy-and-hold strategy. If, for example, someone sells off their stocks during a panic, they could see them go back up in value again in a few days or weeks. If anything, depending on your strategy and goals, you may want to consider buying stocks during a market correction, because prices will have lowered.
You could consider whether you have available funds you’d like to invest during a downturn, and decide if you want to purchase more shares of stocks you already own or if you want to find new stocks to buy. Diversifying the stocks in your portfolio may help you weather the storm of a market correction.
If you do choose to purchase stocks during a market correction, be aware that their value may continue to decline before it recovers again. There’s also no guarantee that it will.
Also remember that the market has bounced back from some severe corrections and crashes over the years. Corrections happen every year and can be healthy for the market.
Behavioral Biases to Watch During Corrections
For investors, corrections can be disorienting and emotionally fraught. You feel like you need to make a move, especially if you’re seeing the value of your holdings decline before your eyes.
With that in mind, it’s a good rule of thumb to try and disconnect from your emotions and make grounded decisions in line with your investment strategy. That may mean you don’t do anything at all; it may mean that you actually invest more to take advantage of a dip in prices. The point is, corrections are often a time during which markets are in flux, and you should do your best to keep a cool head while things play out.
Identifying Causes and Signs of Market Corrections
There can be numerous reasons that the market experiences a correction. And they typically can’t be predicted with any real sense of accuracy.
Key Factors Leading to Corrections
Since so many things could potentially lead to a market correction, it’s hard to say with any certainty what, exactly, is or was the catalyst. But generally, things like rising prices (inflation), slow economic growth, bad or disappointing corporate earnings reports, or even surprising news — say, a war breaks out, or some sort of political upheaval takes place — can cause the market to see a steep decline into correction territory.
Can Market Corrections Be Predicted?
As mentioned, market corrections can’t really be predicted. While it’s almost certain that there will be corrections in the future, discerning when, exactly, they’ll happen is nearly impossible — nobody has a crystal ball.
Technical Indicators That May Signal a Correction
There are many technical indicators that could possibly signal a market correction. Some are fairly common and straightforward, while others are not. That can include certain candlestick patterns, the Hindenburg Omen, and the Elliott Wave, among other things.
It can also include looking at moving averages, and trends of market indexes to get a sense of which way the market is heading.
Coping With Market Corrections as an Investor
Market corrections are going to happen, it’s a near certainty. But that doesn’t mean investors need to panic every time the market has a hiccup.
What to Do During a Market Correction
The first step in knowing what to do during a stock market correction is to find out why it’s happening. If possible.
Next, look into your individual portfolio and see how it’s being affected by the correction. This will help you decide whether to buy, sell, or hold on to the stocks in your portfolio.
Remember that stock market corrections are normal. If you have a long-term investing strategy, you will likely see market corrections, bear markets, and recessions during your years of investing. Try to stay calm and reconsider decisions that might be made based on fear or panic. It may not help to obsess over the value of your portfolio on any particular day.
Long-term Strategies for Handling Market Volatility
In terms of handling market volatility over the long term, here are some things and overarching principles investors can try to incorporate into their investment strategy.
• Have a plan: Buying stocks without a plan can lead to an emotional rollercoaster when they fall in value. Know what your goals are and plan for them, being aware that market volatility is a part of investing. Even when the market corrects, remember that you may still reach your goals for the year or over the long-term if you planned for them. If you’re investing money to use in just a few months versus for your retirement, your strategy may look very different.
• Diversify: One way to help protect your portfolio from significant market crashes is to spread out investments over different types of assets. This is called diversifying your portfolio, and this tactic may help lower your risk of losses while still exposing yourself to potential gains. You can diversify into many different types of investments, including bonds, real estate, commodities, and simply by holding cash.
• Consider cashing out: Investors can be afraid to cash out of a particular stock because it may continue to rise in value. If you own a stock which has gone up significantly, you may want to cash out some of the investment and diversify it into other investments.
• Keep risk tolerance in mind: If you are growing your portfolio for long-term use, you can likely handle a few ups and downs in the market cycle. However, if it causes you too much stress to see your portfolio go down in value a lot in one day, perhaps it’s better not having so much invested in stocks.
• Don’t try to time the market: On the same note, selling off your investments because you think the market is going south may not be a great strategy. The stocks you’re holding may continue to go up in value, and even if they do crash, trying to time your reentry can be just as challenging as timing your exit.
• Think long term: Day trading and short-term investing are risky. If you build a diversified portfolio which you plan to keep invested for a long time before using it, it may be able to withstand cycles in the market and still continue to grow.
Emotional Discipline and Investor Psychology
As discussed, market corrections can be psychologically trying for investors. That’s especially true for those who don’t have much appetite for risk. So, it can be important to keep your wits, remain disciplined, and keep your larger strategy or investment plan in mind. Truthfully, investors should anticipate market corrections; they’re going to happen whether you like it or not.
So, remember that corrections are simply a natural part of the market cycle, and do your best to stick to your strategy.
Real-World Examples of Market Corrections
As noted, corrections are common. In fact, the S&P 500 entered correction territory three times during 2022. It also happened more than once in 2023, and as of writing, the most recent market correction occurred during October 2023, as the market slid for a few months after topping out at a previous high in July 2023.
The Takeaway
Stock market corrections are when the market falls 10% from a previous high, and they’re common parts of the market cycle. As you build your portfolio and mentally prepare for the next stock market correction, remember that you are not alone. Market crashes, dips, and corrections are stressful for everyone, and there are tools and specialists to help you navigate them.
Working with an investment advisor may help you stay calm throughout economic cycles. Planning your portfolio for diversification and long-term growth may also help you ride the waves of the market.
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FAQ
What happens in a stock market correction?
During a stock market correction, the market slides at least 10% from a previous high due to any number of factors.
Are corrections good for the stock market?
Corrections can be good for the stock market in a similar way that a wildfire can be good for a forest — they can serve as a reset to valuations that may have gotten too high, and lower security prices for investors looking to deploy capital.
How long do stock market corrections last?
There’s no telling how long a correction could last, but it’s important to keep in mind that historically, the market has always bounced back given enough time.
What is the biggest stock market correction of all time?
The biggest drop in the S&P 500 in a single day was in October 1987, when the index fell more than 20% into a bear market.
How often should you expect a stock market correction?
Since the 1950s, the S&P 500 has experienced dozens of market corrections, and that means that one occurs less than every two years, on average.
How many corrections have there been throughout history?
Since 1974, there have been 27 market corrections, while only six of those grew in severity to become bear markets.
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