If you’ve been investing in the stock market for a while now, you may have witnessed that the market often falls and rises by a significant degree. Broadly, we call these trends bearish or bullish movements respectively. However, you may have come across financial experts who often use a different term to refer to some significant market movements. The term we’re referring to is a stock market correction.
So, read on to know what stock market correction is, why it happens and how you can deal with it.
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What is Stock Market Correction?
Stock market correction or market correction is a phenomenon where an asset, a sector or the market as a whole experiences a significant decline. Market experts often use this term to refer to price declines exceeding 10% from the most recent high.
For instance, let’s say that the price of a stock recently touched a high of Rs. 2,500 per share. A few days later, it fell to around Rs. 2,200, a price decline of more than 10%. Such a phenomenon is what is termed a market correction.
Also Read: What is a Bear Market?
What Causes a Stock Market Correction?
Since you now have a fair degree of understanding about the meaning of stock market correction, here are the reasons for it to happen..
- Overvaluation
An extended bull run can sometimes cause the value of stocks to become overpriced. When the stock prices don’t justify their intrinsic value, there’s usually a market correction to bring the prices to a more realistic valuation.
- Financial Performance
The stocks face a quick fall if a company offers less than ideal results. A major reason for stock market correction, therefore, is the financial performance of individual stocks.
- Internal and External Crises
Crises of all natures such as corporate governance, mismanagement, geopolitical, health and economic usually spark a major market correction. The recent market decline due to the COVID-19 pandemic is a good example of a stock market correction in India.
- Investor Sentiment
Fear, greed or weak investor sentiment leads to lower demand, which can also be a cause for stock market corrections.
Also Read: What are Shares – Meaning & Types of Shares
Important Things to Know About a Stock Market Correction
Market corrections often spark panic among investors. However, it is important to remain calm and ride out the turbulent period. Here’s a close look at some of the things you need to know about such corrections.
- They’re Usually Short
Stock Market corrections are generally sharp and don’t last for more than a few months. After going through a correction, the markets often bounce back up significantly.
- They’re a Normal Part of the Market Cycle
The stock market generally goes through both high and low phases. This makes corrections a part and parcel of the stock market cycle.
- They Generally Only Affect Short-term Investors
Since stock market corrections are predominantly short-lived, they tend to only majorly affect short-term investors. Although long-term investors do tend to get affected, it is often only temporary since the market eventually bounces back.
Also Read: The Benefits of Investing in Stocks
Stock Market Correction vs Stock Market Crash
As you’ve already seen, a stock market correction is a price decline of more than 10% from the recent highs. This limit is considered a correction, however, when it falls beyond this limit there is a chance of stock market crash.
The crash occurs when the prices fall by more than 20% from a recent high. If the market continues to fall for an extended period, it is termed a bear market.
In other words, a market crash can be described as an intense stock market correction. To put it simply, all stock market crashes start as corrections but not all corrections end up in a crash.
Tips to Deal With a Stock Market Correction
As an investor, you’re bound to face a stock market correction sometime in the future. That is why it is crucial that you remain ahead in the game.
Here is how you can manage to stay ahead of the curve and manage the situations efficiently:
- Keep your portfolio diverse and invest in different assets to stay insulated from market corrections.
- Having a long-term investment outlook can help you deal with corrections more effectively.
- Investing in safe havens like government securities can lower the impact of market corrections and provide a regular source of income.
Conclusion
This sums up the key details of a stock market correction and how you can manage such market movements efficiently. Since such corrections are an inevitable part of investing and trading, it is a smarter move to learn how to navigate them rather than fight the effect of corrections on your portfolio. In fact, with the right approach, you can even use market corrections to your advantage.
Once you have the theoretical knowledge of how to handle stock market corrections, you must look into the practical essentials needed to trade successfully in the market. Top among these requirements are demat accounts and trading accounts, both of which are offered by Bajaj Financial Securities Limited — your trusted stockbroker and registered DP. Open your demat and trading account today to begin your investment journey.
