What is Market Correction?

In the field of finance and investments, a correction is referred to as a change in the stock price from its recent peak state. Usually, a market correction occurs when there is a decline of 10% or more in the price of security such as individual stocks, currency markets, indices and any asset which can be traded on an exchange.

Assets, stock exchange indices, or the entire capital market itself may fall into a correction for days, weeks, months or a longer sustained period. However, market corrections are generally short-lived and last for about three to four months as per the recent financial analysis.

Why Does Share Market Correction Occur?

Market corrections are an indicator of a healthy stock market as a continuous rise in the stock market might have adverse implications for an economy. Rising share prices are synonymous with an economic boom; a persistent increase in the values of benchmark indices might thus lead to high levels of inflation, affecting resident individuals, particularly low-income groups. Market corrections also restrict an asset from becoming overinflated, thereby preventing an asset bubble.

Though unpredictable, market correction also encourages investments among long term traders, as they can enjoy wealth accumulation through capital gains when the market recovers.

Such a fall in share prices is significantly different from bear markets, as market corrections allow an economy to grow even further upon readjustment of the prices of securities as per their real value.

How to Identify a Stock Market Correction?

Financial analysts and investors take the assistance of several charting methods to help them predict and track market corrections. It is quite challenging to analyse when such a correction takes place as the reasons behind it range from large-scale economic changes to financial issues in the management strategy of a single organisation.

A change in the stock market rates occurring in the course of a trading session is unhealthy for short term traders who could face significant financial losses during such periods.

As it is difficult to predict market correction 2020, it is inconvenient even for the experts to estimate the starting and ending periods of such a decline in stock prices.

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Factors to Consider Regarding Stock Market Correction

Market corrections may give off a scary vibe, but it is not necessarily always a bad omen. There are several factors to consider for the realisation of both positive and negative aspects of such a correction in the stock prices, which are elucidated in the table below.

Factors to Keep in Mind Brief Explanation
  • A stock market correction is mostly short-lived
In comparison to bull markets and bear markets, market corrections last for a shorter period, usually sustaining for 3 to 4 months.

However, recent share market trends indicate that Nifty50 shifted below up to 60% retracement heights which were considered as the risk consolidation level for October 2019. During this time, there was a rise in the stock exchange index for about 1000 points which indicated the last market correction to be inevitable.

  • Such corrections are routine
Market corrections are an unavoidable part of security ownership, and there is nothing an individual can possibly do to resist a correction from occurring. Individuals who are relatively new to stock markets are unaware of the fact that market corrections are a frequent occurrence.

The economic condition of any country is bound to peak and trough over a certain period. Accordingly, the price of stocks will also change, thus enabling frequent share market corrections.

  • Affected personnel
Correction of the stock market will affect your investment strategies only if you are a short-term trader. Those who are focused on long term investments are barely affected by the nominal fluctuations in stock prices. Investors who buy and sell securities regularly are the ones who are affected the most due to a share market correction.
  • The ideal time to invest in value investment stocks
A correction in the share market is often an ideal time to invest in high-flying stocks at a substantial bargain. It is a well-accepted fact in the world of share market – higher the potential of your return on investment, greater will be the financial risk associated with it.

If the price of a stock increases at a rapid rate, the potential return from future investments is supposedly lower. Hence, right after a correction in the share market or recession, the potential for return on investments in the near future is higher in comparison to a steady market.

  • Long term investments
Prices readjusting after a market correction tend to rise over time, allowing individuals to enjoy capital gains.

For long-term investors and traders, such a correction is often the ideal time to invest in high-flying stocks at a substantial bargain. It is not advised to aim for stock purchase during market corrections only, but financial experts believe that during such a period, adding such stocks to your portfolio is an excellent plan for long-term investment.

How to Deal with Market Correction?

Most individuals attempt to participate in an inflated market by switching their funds around several stocks so that during a market crash, substantial losses can be avoided. Such a practice is referred to as behavioural finance in the field of investments and share market.

Data indicates that the common mass not only lack the financial discipline to stick with a rising stock, but they also tend to surrender a share at an ill-advised time leading to increased financial losses.

When market correction 2020 takes place, it is bound to affect all equities; so, one should be prepared and opt for the following methods and techniques to avoid substantial losses –

  • Opt for asset allocation

Asset allocation is a variant of financial planning, whose primary objective is to balance market risks and rewards by distributing one’s investments across multiple securities. It is advisable to lower financial exposure to upcoming market corrections as one comes close to retirement. Hence, one should partake in the safer options by opting for asset allocation so that substantial financial losses are not incurred during a decline in the stock prices.

  • Lock-in the investment portfolio

As stated above, individuals having a long-term investment outlook are more likely to realise substantial profits through the stock market. Market corrections are primarily short-lived, lasting 3-4 months. Upon readjustment, the true valuation of stocks is soon reflected as aggregate demand in the economy picks up.

Keeping a corpus invested during this time instead of panic selling the same helps individuals realise wealth appreciation through the resale of securities when the prices adjust as per their corresponding demand.

  • Invest in government securities

The intrinsic value of government securities doesn’t fluctuate with price variations, as the central/state governments back them. Individuals wary of stock market investments during times of market correction can choose to allocate their portfolio to such instruments, as they come with the security of principal and fixed interest rates.

Market Correction vs Bear Market

It is a common mistake among the common masses to confuse the terms – market correction and a bear market. The latter comprises a falling economy where stock prices decline at a steady rate. A decline of at least 20% is considered for denoting a market to be bearish, whereas market correction takes place during a 10% fall in the stock prices.

The aggregate cash flow is notably insubstantial during a bear market, thus leading to a significant reduction in demand and supply in an economy. On the other hand, a market correction is an automated adjustment of the existing stock market prices followed by a bull market.

So, if you are a novice stock market investor, the above discussion would help you understand that a share market correction in the Indian capital market is bound to happen. Hence, financial experts advise remaining cautious of investment in an unstable market to avoid any unnecessary financial losses.