What is a stock market correction and how to deal with it?
A stock market corrections are regularly interpreted as a drop in stock prices of 10% or higher from their most recent peak. If prices drop by 20% or more, we call it a bear market.
Prices bounce, excitement hides logic, signals arrive and disappear. The reasons for treating equities as a poor barometer for the economy are many. Right now, that might be for the best. Stock market corrections occur, normal, about every 8 to 12 months, and last about 54 days.
A 5% to 10% correction is vital for this stock market, warns Jefferies strategist.
What happens when the market declines, why it does so, and how long a drop may last?
For example, news that the S&P 500 has fallen more than 3% in one day can cause uncertainty even for the most experienced investor. Such falls can be scary because it’s impossible to predict how difficult or long-lasting losses will be. And even if you believe the market will finally rebound, it’s hard to follow the value of your investments shorten in front of your eyes.
But, a stock market drop doesn’t mean it’s time to panic.
Since 1926, there have been 20 stock market corrections during bull markets, meaning 20 times the market declined 10% but did not subsequently fall into the bear market territory.
You have to know, the stock market’s condition is always rising and falling. Occasionally, the market will experience short-term gains, but after will come drops. And again, and again, the same scenario. The gains in value are usually due to mass psychology because investors are driven by the expectation of recognized gains. When more investors buy into the trend, the price increases. Once the price is high enough, buying slows, and some investors begin to sell to lock in their gains. This decrease in price, following a short-term increase, is a market correction.
Stock market corrections are followed by…
Market corrections are usually followed once an increase in market prices has come and gone. A correction in a stock’s price following an upswing is characteristic of a stock’s true market value. It may not indicate a loss in value because it shows a market’s return to balance.
Market corrections are a significant part of technical analysis. Many investors will use indicators to try to determine when the correction will begin and end in order to buy when prices are lower.
Why the stock market crashes?
The market drives for many reasons. It can be because the economy is weakening or because of investors’ perceptions and emotions. The fear of loss, for example, is one of those reasons.
The market dips because investors are more motivated to sell than to buy. That’s a simple law of supply and demand. However, it doesn’t explain why investors are selling.
Investors are looking in the future. They try to determine if their investments will increase in value. Investors watch for signs, news, rumors, and all about how the market will move.
While the reasons for a one-day drop may change, a longer-term decline is usually caused by one or several of the other reasons:
A slowing or reducing economy
This is a “fundamental” reason for the market to sink. If the economy is slowing or entering a recession, or investors are expecting it to slow, companies will earn less. Hence, investors bid down their stocks.
In the stock market, the opposite of greed is fear. If investors think the market is going to drop, they’ll stop buying stocks, and sellers will going lower with their prices to find buyers.
The absence of “animal spirits”
This an old maxim. It refers to the waves of investor emotion and risk-taking through a bull market. As they see the chance for profits, people enter the market, pushing stock prices up. When this animal spirit dries up? When the fear is on the scene.
Outside and big events
This mixed category includes everything that might frighten the market: wars, attacks, oil-supply shocks and other events that are not completely economic.
And what happens today? Are we approaching a point where we will see how much gravy is left in this stock market?
Are the stock market corrections really vital for today’s stock market?
There are several signs of a stock market correction. Last year was the most volatile year in the stock market since the recession. The volatility can increase stock market crises. But, volatility is just one reason the biggest hedge fund managers and respected economists are predicting a 2019 crash.
Another reason is the rising interest rates.
Increasing interest rates is a strategy to control the rise of inflation. How does it work? Increasing the cost of credit and making saving more attractive hits a balance between spending and saving.
Though, this approach can be dangerous. Lower buyer spending has a negative influence on the revenue of the businesses.
Decreasing revenue causes slips spending across both the consumer and business aspects. At the same time, higher interest rates make it harder for financially weak companies to meet their debt obligations.
A wild flow can lead to economic depreciation, dropping stock prices, and stock market crashes. It’s not surprising that interest rate hikes have preceded over 10 economic recessions in the past 40 years.
Rising volatility and interest rates are affecting investors and economists to warn of an approaching stock market crash.
According to hedge fund manager Paul Tudor Jones, “We have the strongest economy in 40 years, at full employment. The mood is euphoric. But it is unsustainable and comes with costs such as bubbles in stocks and credit.”
Scott Minerd, Chairman of Investments and Global Chief Investment Officer of Guggenheim Partners has forecast a 40% retracement, while economist Ted Bauman believes the market could fall by 70%. Finally, the CIA’s Financial Threat and Asymmetric Warfare Advisor Jim Rickards has claimed that a 70% drop is the best-case scenario.
How traders can take advantage of stock market corrections
Honestly, along with great volatility can come great rewards. The right financial tools give traders the chance to profit no matter if markets are rising or falling.
Advanced traders can switch any potential market crash into a profit. They know how to hedge their existing investments until the market turns. In such periods they implement short trades. Despite, the volatile markets can produce higher trading risks. So proper risk management and volatility protection are essential.
How to deal with a stock market corrections
Most traders lose money when trying to move their money around to join the ups and avoid the downs.
Most people lack the discipline to stick to a winning investing playbook in correcting markets. Also, they tend to transact at the wrong times causing even bigger losses
In the past 5 years, the Dow Jones Industrial Average has almost doubled without any important pullback. For each of those years, a notable number of analysts have called for a correction or even a recession. These forecasts pushed investors to pull out of the market too early and lose the important gains.
If you are going to invest in the market, it is best to understand that stock market corrections are going to occur. Often, it is best to ride out your mix of investments that have more potential for less risk.
Resist the urge to trade and profit from them. Remember, never catch a falling knife.