Despite the expectation of daily stock market changes, the impending scare of a big drop looms.
Emerging now from the worst year for investors in a decade, it’s likely the coming year will be another volatile one for the stock market.[1] Still, there’s no need to panic.
Stock market corrections can be hard to endure, but they’re a common occurrence. Even though markets tend to revert to their average performance over time, watching your investments dwindle is unsettling.
When the market goes down, is it cause for concern or just an expected correction in the market?
To answer that question, and to help you get your money’s worth this year, here’s what you need to know about a stock market correction.
What is a Stock Market Correction?
A stock market correction is when any security or market index drops at least ten percent from a recent high. Interestingly enough, these occurrences are relatively common.
Stock market trends naturally fluctuate over time. When they’re up, everyone is happy and filled with excitement. But when the value goes down, fear sets in as investors watch their portfolios shrink. Often, this is merely a correction in the market, and there’s no reason to panic.
Depending on your risk tolerance, you might feel mildly uncomfortable or on the verge of a full-on panic attack when a stock market correction occurs. But the stock market is expected to drop. A correction in price following a short-term rise isn’t so much a loss in value as it is a market’s return to stability.
8 Things to Keep in Mind When the Stock Market Drops
If you’re new to stock market investing, these abrupt highs and lows can cause you to worry. Even seasoned investors might not appreciate these swings. However, corrections are an unavoidable part of investing.
During a market correction, there’s nothing you can do to stop it from happening. Plus, you risk losing more money by moving your investments around to follow the ups and downs. Instead of attempting to time the market, remember these eight things the next time the stock market drops.
1. Stock market corrections are common
Keep in mind that stock market corrections are common. They happen fairly often as markets rise and fall over time. According to Deutsche Bank, corrections of 10% or more occur every 357 trading days, or roughly every one and a half years.[2]
When was the last stock market correction?
According to market analytics research firm Yardeni Research, the S&P 500 index has tolerated 37 corrections since 1950.[3] Though they’ve been intermittent since the Great Recession, the last two stock market corrections occurred in 2018: once in February and again in October.
As you can see, the stock market doesn’t follow averages, which only reinforces that stock market corrections aren’t necessarily a cause for concern.
2. They’re usually driven by emotion
A stock market correction typically follows a recent increase in value, and it’s usually driven by emotion.
When you think prices are going to rise, there’s the anticipation of perceived gains, and you buy more stock hoping to make more money. But you aren’t the only one, and the expected increase ignites excitement that drives the price up as more investors buy into the trend.
The buying of stock eventually slows, and the price begins to fall as you and other investors start selling your shares to lock in your gains.
This buying and selling based on perceived gains and losses is the emotion that drives a stock market correction. But it isn’t necessarily a loss in value. Instead, the decline indicates the stock is returning to its true market value, which brings stability back to the market.
3. A stock market correction typically doesn’t last long
Watching your investment portfolio drop is like a kick to the gut. It feels like the air is escaping your lungs and it’s all you can do to hold your breath. But when you’re in a stock market correction, remind yourself that it won’t last long.
Looking at the corrections the market has seen since 1950, more than half — 61 percent, in fact — lasted 104 or fewer days.[4]
There is a potential for short-term losses during these often brief periods of corrections, but the market leans toward stability. In the last ten years, stocks have outperformed all significant forecasts more than any prior ten-year period.
4. Stock market corrections are difficult to predict
Analysts can add up the number of stock market corrections and arrive at an average to get an idea of how often they occur. However, the market doesn’t adhere to the law of averages. The reality is that you can’t predict when a correction will happen.
In an attempt to protect yourself against potential losses, you can try to analyze and forecast when there might be a correction. But even the best technical analysis of market averages doesn’t provide a clear picture of market expectations.
5. We only know causes after the stock market drops
The market can fall for many reasons, including a weakening economy, the emotional response of investors and their perceptions, or the fear of loss. You may see signs in the news and in rumors on how the market will move, and sometimes the evidence can point to some political and economic elements.
Many factors have the potential to cause a drop in the market, and no one can ever know what the market will do until after it happens. Though you can speculate, there are too many components to know what causes a correction until after the stock market drops.
6. They’re not impactful in the long run
Like a speed bump, a stock market correction has little impact on your route in the long run. You might feel the bump, but you resist the urge to panic and keep accelerating forward on your journey.
Though it won’t have much of an effect on your long-term investments, short-term traders tend to be more driven by their emotions. A knee-jerk reaction can cause significant loss during a correction period. Long-term investors, on the other hand, can use this as an excellent opportunity to reassess their portfolio.
As you review each of your investments, ask yourself why you bought the stock in the first place. If that reason is still valid today, it’s probably best to keep holding on to it. Otherwise, you may want to consider if you will benefit from selling.
7. When the stock market drops, it’s a good time to invest
The reduction in price during a correction period could give you an opportunity to add investments from high-quality companies. Trying to time the market is rarely a good idea, but you can use this fall in value to buy stocks that might have otherwise been too expensive.
To best prepare for a stock market correction, learn enough in advance about the companies you might want to invest in. Then, when the time comes, you can load up at a lower price.
History has shown the potential is more significant for higher returns just after a stock market correction. You don’t have a crystal ball to predict when it might happen, but you can be ready to jump in and boost the overall performance of your portfolio when it does.
8. Dividends and value stocks tend to be best
If you want to build a more resilient portfolio, dividend and value stocks tend to perform the best during an economic slowdown.
That’s because high-quality dividend and value stocks will generally lose their worth at a slower pace than growth stocks. A stock market correction is an excellent time to seek out the best value stocks, and you’ll want to look for ones with a history of strong earnings and solid balance sheets.
Related: How to Get Started Investing with $100
Don’t Panic About a Stock Market Correction
Most sound investment plans are designed to endure market volatility and perform according to the appropriate risk level of your portfolio. Since they are difficult to predict, if you have a long-term investment strategy, sometimes the best reaction is to stay the course.
While stock market corrections happen reasonably often, they typically don’t last long. Though it can feel like a shock, history has proven the market eventually recovers from corrections and they’re generally not a cause for alarm.
