Dow Correction: 3 Things to Expect When It Comes

People are talking about a correction as if it has already happened, but this week's pullback was nothing of the sort. Here are three things to get ready for.

Apr 12, 2014 at 11:00AM

The Dow Jones Industrials (DJINDICES:^DJI) fell almost 1% on Friday, capping a week that took 385 points off the average and left those who had watched the Dow soar nearly to new all-time record highs just the previous week feeling shell-shocked. But even though some have already referred to the mild declines that the Dow Jones Industrials have seen as a correction, investors who've forgotten what the bear market of 2008 was like might need a brief reminder of what a real Dow correction will look like. Here are three things to watch out for.

Bear Market Jean Pierre Lavoie
Source: Wikimedia Commons, courtesy Jean-Pierre Lavoie.

1. The losses will look ugly.
Many commentators still refer to triple-digit gains or losses in the Dow Jones Industrials as if they're particularly eventful. But with the Dow still above 16,000, 100 Dow points is a move of just five-eighths of a percent -- hardly a huge market move by historical standards. Similarly, those who remember the Crash of 1987 might recall that the Dow lost 508 points in a single day. At the time, that represented a drop of more than 22%, but today, it's just over a 3% decline and not even worth of correction status.

By contrast, even a 5% mini-correction will mean a drop of more than 800 points from the Dow's recent highs, while a full 10% correction would require a decline of 1,650 points from the Dow's year-end 2013 levels. When that happens -- and it will happen -- many will panic, but taken in context, it will still be just a simple correction and something that occurs regularly.

2. Don't expect it to happen overnight.
One of the things that investors have gotten used to is for market corrections to come quickly. Certainly, in the past, we've seen numerous occasions when sharp declines came in relatively short periods of time, including the aforementioned 1987 crash and the 2008 financial crisis and market meltdown.

But the corrections that are hardest for investors to endure are long, drawn-out affairs, where the market keeps tempting investors to buy dips only to have their hopes thwarted once again. Long periods of unfavorable markets like the 1970s show just how painful it can be when stocks go nowhere. You need to prepare yourself for what seem like an endless series of setbacks resulting in a general loss of confidence in the stock market as a whole. Indeed, that could be the best result, because investors who buy stocks at the moment of greatest fear will likely reap the biggest rewards.

3. If you wait for it to come before you plan for your investing strategy, it'll be too late.
It's important to prepare for a Dow correction before it actually arrives. By knowing what you'll do before you have to do anything, you'll be better able to think clearly and rationally when the time comes, executing on your strategy before emotions can get the better of you.

You can see the value of such a strategy just by thinking back to the 2008 financial crisis. During the market meltdown, investors sold stocks indiscriminately, bidding down fundamentally strong stocks on ridiculous theories. Starbucks (NASDAQ:SBUX) lost 80% of its value as investors somehow believed that people would stop spending money on coffee. Procter & Gamble (NYSE:PG) fell by roughly 40%, only to regain most of its lost ground within the first year after investors realized that people would still need consumer goods. Obviously, some stocks failed and never recovered -- but never underestimate the power for investors to be irrational in their fear.

In many ways, long-term investors should actually hope for a Dow correction. But whether it comes now or later, remember these three things, and they'll help you make better investing decisions whenever the Dow correction becomes reality.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble and Starbucks and owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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