Stock market corrections occur when major market indexes decline by 10% to 20%. Investors must accept that corrections are an inevitable part of life since, on average, one occurs every two years.
When the stock market goes through an abnormally high period, a “correction” returns values to their longer-term trend. In other words, the market is corrected to reflect its more consistent, typical behavior over time.
Sometimes corrections turn into bear markets during which market indexes decline by at least 20%. But bear markets are rare, and usually, corrections simply re-establish the status quo.
What Causes Stock Market Corrections
Investors’ motivation to sell rather than buy represents the primary cause of stock market corrections. Even though an infinite number of factors can cause short-term corrections, longer-term corrections are usually the result of a few factors.
A slowing economy, a recession, or the anticipation of one or the other, will cause consumers to spend more conservatively, excluding luxuries so they have enough food to put on the table. Companies, therefore, earn less money and lower their stock prices.
The opposite of greed in the stock market is fear. And a market’s downward trajectory stokes investors’ fears. Investors will stop buying stocks if they expect the market to fall, forcing sellers to lower their prices.
National or international events can also rattle the stock market. Whether war, pandemic, or environmental disaster, if the supply chain and people’s morale are affected, so is the stock market.
What To Do During a Stock Market Correction
It’s one thing to know what a correction is, but it’s even more important to know what to do when one occurs. Here are some tips:
Apply Logic and Reason
Stock market corrections can make you nervous. So when there is a correction, the first rule is to get some perspective on the reasons for the downturn. Do your research and discover what’s causing the correction and if it’s affecting both national and international markets.
Choose Your Information Sources Carefully
Maintaining perspective can be challenging if you’re too dialed into the minute-by-minute market swings reported by many news programs. Or if you let yourself be convinced by gossip and hearsay. You cannot make sound decisions based on how much you lost or gained in a day or on the opinion of your uncle. Instead, study the trends and listen to experts’ advice.
Making a financial plan takes a lot of time. After reading reports by subject matter experts, working with a professional, and making the best decisions you can given your personal finances, you’ll have a solid investment strategy. So trust that strategy even during a correction.
Minor Tweaking May Be Necessary
That being said, during a stock market correction, there’s no reason you shouldn’t reevaluate your old decisions. For example, five years prior, you may have built your portfolio on technology stocks. Perhaps now you’re worried about certain tech stocks being too risky or that government regulation will change the profitability equation for the industry.
Market downturns can be an opportunity to reevaluate your plans and adjust if necessary, so don’t waste the opportunity to analyze an older financial strategy against a new financial landscape. As with all stock market-related matters, a cool head, lots of research, and professional advice will help you and your investments thrive, even during a correction.