Correction, downturn, bear market — there’s a whole host of terms that get thrown around regularly when the markets are moving downwards. While it’s not always wise to get too caught up in the day-to-day fluctuations of the stock market, it is good practice to alert yourself to wider trends.
Hearing these terms is one thing, but understanding them is an entirely different prospect. With that in mind, we’re going to specifically focus on a market correction to find out exactly what this particular phrase means.
Definition of a market correction
Straight away, we run into a problem. Unfortunately, there’s no real universally accepted definition for what a correction actually is. However, the majority of people would consider a market correction to have occurred when any major stock index — such as the S&P 500 (NYSEARCA: VOO) or the NASDAQ — drops by more than 10%, but less than 20%, from a recent peak.
A market correction can occur over both short and long time periods, spanning mere days up to entire years. However, the average market correction will typically last anywhere between three and four months.
All of the same factors that cause an individual stock’s price to rise and fall can also cause a market correction. Political developments, macroeconomic issues, or global incidents such as a pandemic are all liable to cause a correction.
The difference between a correction and a bear market
A market correction can often be confused with a bear market. A bear market signifies a decline of over 20% in a market. They typically average longer than a correction, with 14 to 16 months being the typical timeframe. Corrections often encompass more immediate events, whereas bear markets are a result of deeper issues that have the capacity to last for a significant period of time.
A correction can, of course, lead to a bear market. But, historically, most corrections haven’t developed into full bear markets. There have been 24 market corrections between November 1974 and January 2022, and only five of them resulted in outright bear markets.
Handling a Market Correction
The most important thing to do during a market correction is to avoid panic. Corrections occur more often than you think, and can often be related to knee-jerk reactions from investors. Our article on How to Handle a Market Downturn should help you prepare for any correction likely to occur.
If you avoid panic and maintain a long-term, buy-and-hold strategy, you’re very likely to ride out any potential corrections that come your way.