When investing in the market you may experience fluctuations up and down continuously over time. Of course, as an investor you generally hope the market will continue to go up since the value of the assets you hold in your portfolio will also go up, adding to your wealth. However, there could be times when the market has reached a certain peak and assets broadly have become overvalued. This may force the market to go down significantly in order to rebalance asset values in a move known as a market correction.
What is a market correction?
Technically, a decline of 10% or more from a recent peak is classified as a market correction. This can occur in either a broader market index or in an individual market asset, such as a bond or a stock.
How long a correction lasts can vary from days to weeks to months or even longer. Usually, market corrections last around three to four months. During this time the market value of the asset or market index will continue falling until it reaches a bottom of the trend.
Predicting a correction
It is extremely difficult to accurately predict when a market correction will occur. Many financial experts will use technical analysis and fundamental analysis in an attempt to determine when a correction in the market is likely to happen. Although these methods can help you prepare, they are far from perfect and will usually not be able to predict exactly when a correction will materialize in the markets.
Part of why market corrections are difficult to predict is the fact that many factors can contribute to causing a market correction depending on the market index or specific asset. These factors can include a major macroeconomic shift or even a single bad decision by an executive of a specific company.
Should you worry about a market correction?
If you have properly managed your risk when building your investment portfolio, you should not be worrying too much about a market correction. Usually since a market correction will only last a few months, if you simply do nothing with your portfolio, you will see the value of your investment assets return to their previous level and even higher. The problem is when an investor is taken by surprise by the market correction and begins to panic and ends up selling assets at the bottom of the market which is the exact wrong time to do so.
One way to limit the losses of your portfolio during a market correction is through diversification. Not all assets will be affected equally during a broader market correction. Some types of assets are more resistant to losses during a market correction than others, despite also having less potential for gains in an appreciating market. Therefore, it is important to have the right amount of these types of assets in your portfolio to match your own tolerance for risk. A professional financial planner can help you find the right balance for you.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of the author and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Raymond James and its advisors do not offer tax or legal advice. You should discuss any investment decisions, tax or legal matters with the appropriate professional.