A major dilemma for investors is to find a way to minimize the effect of economic risks, including market corrections. Nobody wants to see their portfolio make major gains, only to see those gains reduced or wiped out if there is a sharp downturn. One predominant method of trying to limit the downside capture of a portfolio is to dedicate a portion towards investments that move in the opposite direction of the market as a whole. Other risk management strategies include hedging with futures contracts, buying investments that have a low beta or even spreading out purchases to take advantages of dropping prices.

Not all drops in the stock market are necessarily a "market correction." Corrections are large declines of at least 10%, in either an individual security, a commodity, or an index to compensate for overvaluation. Corrections are generally viewed as shorter and less problematic than actual recessions. Generally, investments should be diversified enough so that no single security instrument or commodity can sink the entire portfolio. The following strategies are more specific ways to diversify and guard against market correction.

Counter-Cyclical Investing

If a number of your investments have a high degree of correlation with the market as a whole, then a correction with a major index, such as the S&P 500, the Dow Jones Industrial Average, etc., could spell trouble. By purchasing some stocks or mutual funds of stocks that belong to an industry or commodity negatively correlated with major indexes, you can see some of your portfolio appreciate in price even when the market struggles. These investments are described as "counter-cyclical."


There are many definitions of a hedge, but the general concept is to reduce the risk of a security losing value by making a complementary investment. Counter-cyclical stocks could be considered a hedge. Purchasing real estate, gold or other alternative assets can be considered hedges. One common hedging strategy is to sell futures contracts on a stock, which state that you automatically sell your position at a certain price, avoiding stock-specific corrections.

Dollar Cost Averaging

Dollar Cost Averaging, or DCAing, is not necessarily a risk management strategy but rather a method of making long-term investment purchases in a systematic way to take advantage of short-run downturns or market corrections. Suppose you want to purchase $5,000 worth of a security and hold it for an extended period of time. Rather than making a lump sum purchase right away, you could spread out your purchases, say at $100 per month, and then be able to buy more shares if the price of the security drops. If one month, the price is $10/share, you could buy 10 shares that month. If the next month, the price was $5/share, you could purchase 20 shares. By collecting more shares this way, you aim to have a larger overall gain when the price rises again.

Low Beta Investing

Another way to protect against corrections is to simply be more risk-averse from the beginning and invest in securities that have a low beta coefficient. Your portfolio is less likely to share in market volatility with this strategy.

  1. What techniques are most useful for hedging exposure to the banking sector?

    Learn how investors hedge exposure to the banking sector by investing in more aggressive sectors and also by investing in ... Read Answer >>
  2. What techniques can be used for hedging exposure to the electronics sector?

    Learn how allocating portfolio space to counter-cyclical and non-cyclical sectors allow investors to hedge exposure to the ... Read Answer >>
Related Articles
  1. Trading

    Hedging Basics: What Is a Hedge?

    This strategy is widely misunderstood, but it's not as complicated as you may think.
  2. Investing

    Is a Stock Market Correction Imminent?

    Some insiders say signs point to another correction in the market in the weeks or months to come.
  3. Investing

    Hedging for Beginners: A Guide

    People hedge as insurance against market volatility. Anyone can do it; here's a primer.
  4. Trading

    A Beginner's Guide to Hedging

    Learn how investors use strategies to reduce the impact of negative events on investments.
  5. Investing

    Portfolio Growth Strategies

    There are many ways to grow a portfolio, and the best approach for a given investor will depend upon various factors.
  6. Financial Advisor

    Why Hedge Funds Are Not Living Up to Return Hype

    Hedge funds are supposed to produce better returns while protecting your investments from the downside. Here's why they are not living up to their purpose.
  7. Investing

    How to Prepare Your Portfolio for a Market Correction

    With experts saying a market correction is coming, now is the time to prepare your portfolio.
  8. Investing

    Are Hedged Mutual Funds For You?

    Long the purview of institutional investors and ultra-wealthy individuals, financial services firms are making alternative investment strategies available to a wider audience of investors. Understanding ...
  9. Investing

    How to Updgrade Your Portfolio in a Down Market

    While it may be tempting to sell when the market turns downward, your long-term results may be better if you leave your money and ride it out.
  10. Investing

    Stocks Face Miserable August as Correction Looms

    August has often been a rough month for stocks.
  1. Hedge

    A hedge is an investment to reduce the risk of adverse price ...
  2. Buying Hedge

    A transaction that commodities investors undertake to hedge against ...
  3. Technical Correction

    A technical correction occurs even when there is no evidence ...
  4. Correction Notice

    A notice indicating that a process or application contains errors ...
  5. Inflation Hedge

    An inflation hedge is an investment that is considered to provide ...
  6. Basis Risk

    Basis risk is the risk that offsetting investments in a hedging ...
Trading Center