A correction is reference to a drop in the market of 10% or more pertaining to the price of listed securities , after a strong upswing (uptrend) in the market. So in much simpler terms a correction in the market is regarded as a juxtaposed (contrasting) drop in prices, after there respective significant rise in price.
In the year 2018, we experienced sharp corrections in the market and across different industry, I will be referencing these to demonstrate and show examples of what constitutes as a correction. Two major corrections for 2018 , was the Dow Jones Correction and the S & P 500 corrections, in February. In late October of 2018 , the Nasdaq and the S & P 500 experienced another correction in the market.
What causes a correction in the market?
Corrections are inevitable, and they are not always a bad thing. As the name suggest a correction in the market is to correct an irrational rise in the market. The markets are influence by human psychology, and human behaviour at times can be very irrational and this irrationality is translated in the market. This can cause the price of securities to be either over price, or undervalued. It’s a great thing to be in the market when securities are undervalued, but not the case when securities are overpriced – that is when it becomes expensive to be in the market. Securities become over priced, mostly as a result of a phenomena called irrational exuberance, which inflates the price of assets significantly above there intrinsic value.
Then investors , eventually come to the realisation that there securities are over priced, and this causes a selling frenzy, that causes the price of assets to drop. However , this whole process is regarded as a correction in the market because the drop in the prices, is designed to bring the prices down to align more closely with its intrinsic value.
The implications of a correction.
A correction confirms that the prices of securities in the market were overpriced. A correction in the market should not be mistaken with a crash.
Why are corrections relevant?
Corrections in the market are important if you are a short term investor, as it can have detrimental consequences to your investment portfolio. So watching and evaluating what is in you portfolio is important and will be critical if you are a short term investor. To understand the difference between short term and long term investors you can follow the link here (). The other reason to be aware of when there are corrections in the market, is that you can identify opportunities to build your investment portfolio. Corrections allow investors to buy the stocks they were reframing from (because they were to expensive) at more reasonable costs.