What is market correction and how to prepare for it?

People often mistake a market correction for a bear market or a market crash. The stock market correction could be taxing as investors see major market indices falling and their stockholdings plummeting in value, which could trigger panic-selling. However, this phenomenon is an evitable part of the market cycle after seeing a steady growth for an extended period. It can be viewed as a healthy pullback ahead of the market uptrend.

Predicting when and how much time market correction will last could be tricky even for economists and market experts. Hence, to make sure that your investment portfolio is well placed to handle such market surprises, let us first know about what market correction is and, if there is any chance, how it can be used to your advantage.

What is a stock market correction?

A stock market correction is when a stock market index declines by 10 per cent to 20 per cent. In contrast to a correction, one should note that a bear market occurs when the market index slips by 20 per cent or greater. However, market correction can precede a bear market in case of lasting economic stress. Market correction generally stems from unfavourable market news or economic environment and tends to last for a short period.

Minimizing losses and maximizing gains are equally important for equity investors to prepare ahead of time for possible correction. Hence, here are a few tips by Kalkine Media® to keep in mind.

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1.     Portfolio diversification

Adjusting asset allocation from time to time based on your risk preference is a simple way to diversify your portfolio risk. Proper diversification strategy across different investments can help minimize the impacts of the market correction. Diversification is generally deemed as a healthy habit in the investment world to manage risk.

2.     Aim for safe equities

Low volatile sectors like utility, consumer staples, telecommunication etc., can make your portfolio defensive to market cycles. Such sectors are likely to be less sensitive to the correction due to the nature of products and services they offer, thereby helping reduce correction effects.

3.     Long term investing

As correction tends to stay for a shorter period, long-term investing can help investors embrace these market conditions. One can often find high-priced equities at a bargain price when the market is in a correction phase. A long-term approach can help investors overcome the fear of short-lived market correction.

Bottom line

A market correction differs from a bear market and generally lasts for a shorter duration. Panic selling during the correction phase can result in losses, which could have been avoided. Hence, investors should rationally take investment decisions and manage their portfolios based on their risk preferences.