A stock market correction is defined as a drop of at least 10% from a recent high.
Drops of that magnitude can be scary, but a stock market correction isn't necessarily a bad thing, depending on the context you view the correction from. Here are six important things you really should know about a stock market correction.
1. Stock market corrections happen often
The first thing you should know is that stock market corrections happen -- and fairly often. The U.S. economy naturally peaks and troughs over time, and in response the stock market will also have its peaks and troughs.
According to investment firm Deutsche Bank, the stock market, on average, has a correction every 357 days, or about once a year. Corrections have generally been quite infrequent since the Great Recession. While many investors, especially those new to stock investing simply aren't used to experiencing swings like these, corrections are an inevitable part of stock ownership, and there's nothing you can do as an individual investor to stop a correction from occurring.
2. Stock market corrections rarely last long
In a broader context, while a stock market correction is an inevitable part of stock ownership, corrections last for a shorter period of time than bull markets.
Based on research conducted on the Dow between 1945 and 2013, John Prestbo at MarketWatch determined that the average correction (which worked out to 13.3%) lasted a mere 71.6 trading days, or about 14 calendar weeks.
3. We can't predict what'll cause a stock market correction
Stock market corrections may be inevitable, but one thing they aren't is predictable.
Stock market corrections could come about within any time frame (every few months or after multiple years), and they can be caused by a variety of issues. For instance, we now know the impetus for the Great Recession was the bursting of the housing bubble caused by an implosion of subprime mortgages. But, how many people were echoing that subprime was a problem in 2006 or 2007? The answer is very few people were. Predicting the root cause of the next correction on a regular basis just isn't possible.
4. Stock market corrections only matter if you're a short-term trader
Another important point you should realize is that stock market corrections really aren't an issue if you remain focused on the long term with retirement as your goal. The only people who should be worried when corrections roll around are those who've geared their trading around the short term, or those who've heavily leveraged their account with the use of margin.
Traders using margin could see their losses magnified in a downturn (just as their gains were pumped up during the bull market), while active traders and day-traders could see their losses and trading costs build during a correction. Maintaining a long-term view has been the smartest way to invest in stocks throughout history – and it also happens to be a recipe for a good night's sleep.
5. They're a great time to buy high-quality stocks at a bargain
For the long-term investor, a stock market correction is often a great time to pick up high-quality companies at an attractive valuation. While trying to time a market bottom is generally a bad idea, a market correction can be a great time to add stocks to your portfolio that could make excellent long-term investments, but that previously seemed a bit too expensive.
6. They're also a good reminder to reassess what you own
Lastly, a stock market correction is a good reminder for long-term investors to reassess their holdings.
As noted above, a dip in stocks isn't necessarily a bad thing as it could give you the opportunity to buy or add to your stock in high-quality companies, but it's important that you reassess your holdings to ensure that the thesis of your purchase remains intact. Ask yourself one simple question with each stock in your portfolio: Is the reason I bought this stock still valid today? If the answer is "yes," then no action is required, other than perhaps adding to your position. If your thesis is no longer intact, then it may be time to consider selling your position.
A stock market correction doesn't have to be scary as long as you keep the aforementioned six points in context.
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