Many a times it looks like we are in for a stock market correction and that is not at all surprising. Stock market correction is always around the corner and investors should know what to do when they expect a rough ride.
Sadly markets never tell you in advance if there would be a bear market or if the market is up for a correction and hence it is important to know all about market correction. Let us start with knowing what a stock market correction is.
What is a Stock Market Correction?
Stock market correction is also known as a pullback and this happens when there is a decline of 10% in stock market from its 52-week high price. The stock market correction is a natural cycle which is witnessed very often. Stock market correction occurs after every bull market and this trend has been continuing from the last 40 years or more. Such correction in stock market is always welcomed by experienced investors as this helps the market to consolidate before it reaches new highs.
What causes Stock Market Correction?
Stock market correction is often seen when there is any event which creates panicked selling. Wise investors do not sell when there is a correction as one might not have time to make up for the losses occurred.
When the stock market has a bullish run, all the traders want to earn potential profits and this often leads to irrational exuberance. This is what makes the prices to increase well above their value and the correction occurs when the prices return back to their actual levels.
Is Stock Market Correction Always a Crash?
When Is It a Crash? This is the most common question asked by investors when there is a stock market correction. A correction is quite different from a crash. A market crash can occur when the prices of stock drop to more than 10 % in just one day. Stock market crash often leads to a bear market and this is the situation when one can witness a drop of prices by another 10%, which leads to a total decline of 20% in just a day.
A crash in stock market can also lead to recession which is not the case with stock market corrections. How does it cause recession?
Let’s understand it better with one example. Stocks help corporations to get cash which is in turn used to grow their business. If there is a decline in the stock prices, there is a less chance for the corporations to grow and this will lead to lay off of workers as the company needs to stay solvent. As the employees are laid off, they tend to spend less than before. This leads to lower demand which in turn is lower revenue, which again leads to more layoffs. If such a trend continues, the economy takes a hit and recession occurs.
How to Prepare For Stock Market Correction?
As most of the traders are aware that a stock market correction can occur anytime, it helps to be prepared before hand for the situation. One of the best strategies followed by experienced traders is diversification of portfolio where the portfolio has the right mix of bonds, commodities and stocks. This helps the investors to earn profits from stocks when there are upswings in the markets and remain protected when a stock market correction occurs. With such a diversification, investors can safety run through the hard times when market correction occurs.
Many investors also look at market corrections as the best time to buy stocks but the same has to be done with a thorough research. Never make any rash moves by getting influenced by the market trend. While no one can control as to what happens in the stock market, how we prepare and respond can for sure be controlled. The most important tip to remember is to be patient, have a plan and to stay invested.
As a conclusion, it can be said that a stock market correction for sure helps the stock markets to catch the breath and reach even high peaks. One need not worry till the trend is still optimistic as buying would resume in no time and this would lead to a much stronger bull rally.
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