In the financial market, a correction means a fall in stock prices either regionally or globally. Typically, short-term declines in market prices can be caused by external factors unrelated to the stock’s underlying financial condition. During a correction, stocks typically decrease 5% to 20% in value over the course of a few weeks or even months.
How correction works?
During a market correction, most stocks, no matter they are underperforming securities or industry leaders, depreciate in value. Since both groups can be hit hard during short-term declines, one way to manipulate the market is to sell some of the weaker stocks in the portfolio that weren’t performing very well even before any correction. In addition to mediocre performance, a market correction can also be a good time to sell risky stocks.
A pullback in the financial markets is a good time for investors to assess their risk and reward profile, while a market correction is a reminder that risky investments can be damaging to a portfolio in certain cycles. Because high-quality stocks are in a downward market trend, investors can take advantage of this opportunity to buy expensive stocks when they sell. By investing during a downturn, investors can reap upcoming profits when market prices are low, investors may choose to exit the stock market rather than invest in stocks, and they may flock to safer asset classes, such as bonds, which pay investors a fixed income over time. This is a good way for the market to work, as long as the bond can produce a substantial return.
Key features of correction:
- 5% to 10% decline in value of a security, asset, or a financial market.
- Happening regionally or globally over the course of a few days, several months, or even longer.
- Detrimental in the short term, beneficial in the long term.