What is a Correction

A correction is generally defined as a 10 percent or greater decline in the price of a security from its most recent peak. Corrections can occur in individual stocks, indexes, commodities, currencies or any asset that is traded on an exchange. An asset, index, or market may fall into a correction either briefly or for sustained periods of time, including days, weeks, months, or even longer.

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Understanding Corrections

BREAKING DOWN Correction

Corrections can sometimes be projected using market analysis, and by comparing one market index to a similar market index. Using this method, an analyst may discover that an underperforming index may be followed closely by a similar index that is also underperforming. A steady trend of these similarly slowing indexes may be a sign that a market correction is potentially coming.

Prior to a market correction, individual stocks may still be strong, or even over-performing. Conversely, during a correction period, individual assets frequently perform poorly due to adverse market conditions. Corrections are often seen as ideal times to buy high-value assets at discounted prices for investors with available capital who are willing to take the risks involved.

Although market corrections can be challenging, and a 10 percent drop may be significant for many investment portfolios, corrections are sometimes considered healthy for both the market and for investors. For the market, corrections can help to readjust and recalibrate asset valuations that may have become unsustainably high. For investors, corrections can provide both the opportunity to take advantage of discounted asset prices as well as to learn valuable lessons on how rapidly market environments can change.

Market Corrections in the News

Market corrections occur relatively often. In February 2018, two major indexes, the Dow Jones Industrial Average (DJIA) and the S&P 500 index, both experienced corrections, dropping by more than 10 percent. Both the Nasdaq and the S&P 500 also experienced corrections in late October of 2018. Here is a chart of the S&P 500 highlighting the two corrections that occurred in 2018 (as of late October 2018).

Source: TradingView

Between 1980 and 2018, the U.S. markets experienced 36 corrections. During this time, the S&P 500 had fallen by an average of 15.6 percent. Ten of these corrections resulted in bear markets, which are generally indicators of economic downturns. The others remained or transitioned back into bull markets, which are generally indicators of economic growth and stability.

The average market correction is short-lived and lasts anywhere between three and four months. While this may not seem like a long time in the grand scheme of things, it is easy to see why casual investors may be worried by a 10 percent or greater downward adjustment to their assets during this period, especially if they are new to investing or it is the first correction they have experienced.