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What is a Market Correction?

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  • Written By: Geri Terzo
  • Edited By: A. Joseph
  • Last Modified Date: 31 August 2016
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A market correction in the financial market is when there is a pullback in stock prices, and it can be regional or global in nature. Typically, a correction is represented by a short-term drop in market prices that might be attributed to extraneous circumstances unrelated to underlying financial conditions of a stock. During a correction, stocks typically lose 5 percent to 20 percent of their value in a matter of weeks or months. There is no one way for investors to play a market correction correctly, although there are certain strategies that could work if the investor is in a financial position to make changes.

During a market correction, most all stocks lose value, ranging from poor-performing securities to industry leaders that have otherwise stood the test of time. Because both groups can be battered during a short-term drop, one way to play the markets is to sell some of the weaker names in a portfolio, stocks that were not stellar performers even prior to any correction. In addition to lackluster performers, a market correction might also be a good time to unload stocks that are risky. A pullback in the financial markets is a good time to evaluate one's risk/reward profile, and a market correction serves as a reminder that risky investments can be damaging to a portfolio during certain cycles.

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Because high-quality stocks are most likely trading at a discount during a downward market trend, investors can use this opportunity to buy expensive stocks while they are on sale. Profits generated from selling weak or risky investments might be redirected to high-quality securities. As long as the economic fundamentals of a company are strong, including sales and profits, a stock might be unduly punished during a market correction. This is because either fear or some other short-term event is driving buying and selling activity, but once the dust settles, a solid company is most likely in position to rebound. By investing during a downturn, investors are in place to reap forthcoming profits.

Investors might opt to exit the stock market when market prices become depressed. Instead of investing in stocks, they might flock to safer asset classes, such as bonds, which pay a fixed income amount to investors over a period of time. This is a fine way to play the markets as long as bonds are yielding respectable returns. If, for instance, the interest rates on bonds are equivalent or below what a savings account is yielding, there is little incentive to transfer risk from stocks to bonds.

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SarahSon
Post 4

When I first started investing I was much younger and able to tolerate some risk and needed growth in my portfolio. In my years of investing, I have seen many market corrections, with some of them doing much more damage than others. One problem I had when the market corrected itself was knowing when the best time was to step back in and buy again.

I know that nobody has a crystal ball and knows what the market is going to do, but there were many times when I got too anxious and bought too early.

Now that I am older and don't have as long for my portfolio to grow, I take much less risk. I keep some of my portfolio in bonds so there is more of a balance. Bonds may not be quite as exciting as stocks, but I don't want everything I own to be at the risk of a bad correction.

andee
Post 3

@bagley79 - It sounds like you have done a good job of buying strong companies. At one time most of my portfolio was in tech stocks, and the value of my portfolio took quite a beating.

I have some stocks that have never recovered from a bear market. When the market turned around and other stocks recovered, I had several that kept dropping in value.

When you are in a bull market and everything is going along nicely, it can be exciting to be trading the stock market. I have seen things change pretty quickly though, and get really nervous when I sense there is a change in market direction and a correction might be coming.

bagley79
Post 2

I have been able to pick up some quality stocks at great prices during a market correction. I never try to get the very top or bottom when I buy or sell a stock, but like to take advantage of a good deal on strong companies.

The stock of every company will rise and fall, but if the company still has strong fundamentals, I like to buy them at reduced prices. I never like going through a bear market, but at least one advantage is being able to buy some of my favorite stocks at lower prices.

There have been times I have questioned this and wondered if I really wanted to be in the market at all. If I give it enough time though, the strong stocks will usually bounce back when the correction is over.

sunshined
Post 1

My first experience with investing was through my 401(k) at work. When I first started investing in this, the market was doing pretty good and I was seeing a nice return on my investment.

The first time I went through a market correction was a little unsettling. To see the dollar amount of my investment drop from where it had been was hard to see. Thankfully the first market correction I went through was not a really bad one.

I think that might have discouraged me from continuing to invest in the market. Since then I have also done some market trading on my own and have seen more than one market correction. Even though I have been through them before, it is never good to watch the value of your stocks drop.

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