How to react to a stock market correction?
When we witness a stock market correction, it is difficult to watch these investments fall without knowing how to do anything about it. However, when investing in the stock market, it is crucial to know what to expect and above all to prepare for possible corrections.
A stock price will never go up or down in a straight line. Quite often after a period of prolonged rise or fall, there is what is called a “correction“. We often hear the question “Why is the stock market falling today?” but we very often forget the period of rise which preceded this fall in the stock market.
So, if we agree that this is something regular, it is necessary to understand them but also to know how to react in such situations.
We saw it at the end of 2018, at least what I was mainly hearing, we had seen a significant drop in the stock market. And it is true that at that time this correction seemed quite significant. We are still talking about a drop of about 18%. But very often we forget the rise which preceded this fall in the stock market. To quantify it, we were talking about an increase of almost 60% since 2016.
However, when we look a little further we see that we experienced an even greater drop in the stock market at the start of 2020 of more than 30%.
To support my statements, I put below the chart of the S&P500 (index representing the 500 largest American companies).
What is a market correction?
Although this is still quite subjective, we can speak of a market correction when a stock or an index falls by at least 10% from a previous peak. Based on this definition, we realize that this happens quite often. On the S&P500 chart shown above, we can see that these corrections are quite regular.
As explained, the stock market does not just go up in a straight line, it fluctuates over time. So when the stock prices go up everyone is happy, but when they go the other way everyone panics even though a lot of times there is no reason. This generally allows the market to stabilize.
Many factors can trigger a correction. It can come from running a business directly or from a more macroeconomic, more global reason. For example, the coronavirus crisis may have had an impact on the entire stock market.
Tips for performing during a market correction
During a market correction, it’s easy to panic and try to correct your investments. But often, it is worse than better. Indeed, you cannot do anything against the correction. Since these are part of the landscape for any investor, it is necessary to get used to them. But to help you, here are 8 tips for doing the best you can during a market correction
1. Market corrections are frequent
The best way to see this is by looking at the S&P500 chart we were presenting earlier. We realize that this kind of drop in the stock market can happen quite frequently. Moreover, according to Deutsche Bank, a market correction happens more or less every 357 days. We can add to this the study by Yardeni Research which showed that the S&P 500 had made no less than 37 corrections since 1950. It is therefore something regular and therefore should not make us panic too much.
2. Market corrections don’t last long
The good news, and the bottom line, is that 61% of corrections since 1950 have only lasted for 104 days or less. It’s true that, said like that, it might sound like a lot but it’s not like we can avoid them so it’s reassuring to know that they won’t last long.
3. They are difficult to predict
Market corrections cannot be predicted and are even difficult to explain. In fact, it is often only after the market downturn that we can determine the causes. But there are so many components that can cause the stock market to fall that it’s hard to predict. This is more speculative than anything else. For example, the coronavirus crisis was difficult if not impossible to predict
4. They have no long-term impact
Based on the S&P 500 chart, we can easily see that in the end, stock market corrections have no long-term impact. They are even quickly corrected as we can see on the S&P500 chart.
In the end, if you are not a short term investor, there is no need to worry. In addition, you have to think about the reasons why you invested in this company at the base. If nothing has changed in the meantime, there is no reason to worry as the situation is similar and this correction does not change it. So your investments should quickly regain their value and continue to grow.
5. Now is a good time to invest!
For me, this advice is the most important. Rather than seeing a fall in the stock market as a bad thing, it would be interesting to see the benefits we can derive from these events. Especially if the corrections are meant to be repeated. What if, instead of worrying about it, we realize that these fixes are in fact opportunities? Because in the end, that is what they are. They allow you to buy good companies much cheaper!
So yes, I did say that the corrections were not predictable, but why not find out in the meantime to identify the good companies that you would consider too expensive in normal times? The idea is really to have a list of interesting stocks, and to wait for the discount of sorts. Because that’s the way to look at these situations! You have to stop worrying with every fall and instead start seeing the opportunities that are there. On top of that, we have consistently observed a significant and rapid rise after a correction.
So I am not saying that there are no market reversals that could upset the stock market. The market could also simply turn bearish for some reason. It’s always a possibility, but that’s the risk of the stock market in the end. So it’s up to you to see if you’re ready to take the bet or not.
6. Some stocks are more solid in the face of a correction
So, if despite my various points above, you cannot bear to see your portfolio of stocks decrease drastically, there are solutions to mitigate the effects. First, if you can’t stand these kinds of events, it may be worth looking into other types of investments. Because as explained, it happens quite frequently.
If, however, you want to invest in the stock market, a good idea would be to turn to value stocks (a stock whose price is lower than the fundamental value of the company) or stocks with solid dividends (a stock that has been generating dividends consecutively since a number of years). These tend to lose value more slowly than growth stocks (stocks that are often overvalued following investor expectations).
The key part of this article is really not to worry about market corrections. In the end, the worst thing to do in this type of situation is to sell your stocks for no reason other than the temporary drop in prices. Because that’s when you would lose money. As a reminder, until you sell, you haven’t lost money yet.
The best way to prepare for a correction is therefore to analyze opportunities to buy stocks in the event of a downside. As well as building a strong portfolio that is able to not suffer too much from these corrections. If you are a long-term investor, these kinds of events should not happen to you. The idea here is to really see these fixes as an opportunity to buy at a lower cost!
As a reminder, I am not an investment advisor and my articles are not investment advice but simply analyzes of a situation or facts and the reasoning I derive from them.
And you, how do you react to these stock market corrections? Do you have any other advice to share? Did you learn something? Do not hesitate to share it in comment.