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What Is a Correction

A correction can be a concerning time period as an investor, but it can also be a great opportunity to purchase something ‘on sale’. Corrections are normal, and often appear every 10 or so years in various markets, including the stock market, real estate market, or currency market.

What is a correction and how should you react? We’ll explain what a correction is, and some winning strategies, in greater detail below. 

Correction Definition 

A correction is when a given security declines by more than 10%. For example, if a stock was $100, correction territory would be anything below $90.

However, with volatile individual stocks, a price may swing more than 10% in a given day or week. Therefore, the market at large, such as the S&P 500, or the Dow Jones Industrial Average, is typically used to determine overall market corrections.

Corrections exist in numerous markets. Most commonly, corrections are used when discussing the stock market, the real estate market, commodities, or foreign exchange markets. 

Should You Panic During Corrections

Without question, a correction can create an emotional roller coaster. Stock market corrections in particular fuel the emotions, as stocks can be purchased or sold easily, whereas real estate isn’t nearly as liquid.

With that said, by no means should you panic during a correction or let your emotions get the best of you. If you own shares in great companies, a correction allows you to buy the stock ‘on sale’, which can reduce your average cost per share, and allow you to realize more upside potential.

However, all companies do not rebound after a correction, which is why owning great companies is so important. In the real estate arena, a correction may allow you to purchase a home at a reduced price.

For example, in your area, it may cost $300,000 to purchase a home that fits your needs and desires. During a real estate market correction, you may be able to purchase that home for $260,000 or $270,000!

This gives you a great opportunity to purchase what you want at a lower price. Corrections are not depressions, nor is it the end of the world for your asset class.

It’s not uncommon to see a rebound in the months that follow a definitive market correction. Having enough cash in the bank to make buying in during corrections is a great strategy to adapt. Therefore, you are buying the assets you’d like to own, but you’re purchasing them at a discounted rate. 

Why Do Corrections Happen 

The occurrence of a market correction is not an exact science. However, a market correction typically happens because of fear or uncertainty. 

Fear and Uncertainty

When there is a great deal of fear in the overall market, a market correction can occur. There are numerous things people are afraid of, and this fear creates uncertainty.

For example, people may be afraid of: 

  • War occurring
  • A virus
  • Change in government policy 
  • A new President taking office

When people are afraid, they may sell their assets rapidly to hold onto cash. This rapid sell-off can cause a market correction.

For example, review the stock market chart from March or April of 2020. The COVID-19 virus brought fear to the market, and there was a mass sell-off. In the months that followed, the market had a terrific rebound. 

Additionally, after a market had a strong run upward, people may begin to feel like a pullback is coming. In an effort to sell their assets at the best price possible, they begin selling assets before a pullback.

This tips the domino, and a mass sell-off could occur, ultimately creating the correction that people were so fearful of. Their fear of not getting top dollar for their asset caused them to sell.

The more people that sell, the more supply there is, which brings down the overall price. 

Plan Proactively

The best way you could position yourself for success during a market correction is to develop a plan before the correction even happens. Leaving some cash in the bank that you could deploy into various investments while they are on sale is a great way to maximize your overall return. 

Identifying your purchase price, and the price you plan on selling your asset for will help keep you disciplined and emotionally balanced during a market correction. 

Work With a Professional

Without question, markets can be complex. It doesn’t matter if you’re talking about the stock market, bond market, real estate market, or foreign exchange market.

There are so many nuances and variables to take into consideration, it can feel overwhelming. Working with a professional financial advisor is a great way to ensure you are hedging your risk, and maximizing your returns, wherever possible.

Although predicting a market correction is impossible, a professional financial advisor can help you develop a market correction playbook that you will use if/when a market correction occurs. Having an unbiased pair of eyes review your investments, and your budget will keep you grounded and on the right path.

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